(b) Your treasurer told you how at a previous employer she designed a forward

contract on EUR, against USD. She purchased EUR 1m and as of today 60 days

remain until expiry. The historic rate was 1.350 while the current rate for same expiry

date is 1.500. Assuming the risk-free rates are 3% (simple p.a) in USD and 4% (simple

p.a) in EUR, you want to evaluate the treasurers decision to do so.

REQUIRED:

(i) Compute the fair value of the contract.

[5 marks]

(ii) Explain intuitively without any calculation why the fair value is positive or

negative and how it compares to the fair value at the inception of the contract.

[5 marks]

(iii) Provide at least two real-life examples how this forward contract could have

been used as a hedging instrument. In each example comment on whether the

hedger is better off or worse off, and whether hedging was a correct decision in

the first place, and what are the alternative ways to hedge when perfect cash

flow matching is not possible.