How Forward Contracts Hedge Risk in Foreign Markets


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Which of the following statements best describes forward contracts?

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1. A company wishes to enter a forward contract with a local bank for exchanging Brazilian reals into U.S. dollars six months from now. Considering a current exchange rate of 3.75 reals per U.S. dollar, Brazilian yearly interests of 4% and American interests of 1%, the contract will probably specify an exchange rate of _____

2. You sign a forward contract to exchange 25 million British pounds (GBP) into Canadian dollars (CAD), in one year, at an exchange rate of 0.5600 CAD per GBP. By settlement date, the market exchange rate is 0.5800 CAD/GBP. What would have happened if you didn't sign the contract?

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About This Quiz & Worksheet

You can answer these questions on how forward contracts can hedge risk in foreign markets. See what you know about these markets with questions on topics like a description of a forward contract and the exchange rate for a forward contract with a local bank.

Quiz & Worksheet Goals

The quiz/worksheet will assess your knowledge of the following:

  • Outcome if you don't sign a forward contract and the exchange rate has changed by the settlement rate
  • Benefits of using forward contracts
  • A downside to using these contracts

Skills Practiced

  • Defining key concepts - make sure you can accurately define a forward contract
  • Making connections - use your understanding of a forward contract and how it's connected to exchange rates at a local bank
  • Knowledge application - use your knowledge to answer questions about the advantages of using a forward contract and one of its downsides

Additional Learning

You can keep learning about foreign exchange markets in the lesson named How Forward Contracts Hedge Risk in Foreign Markets. These points will be covered:

  • The exchange rate for different currencies
  • Process of hedging at a business/with investments
  • Forward contract example at a fixed price
  • Reasons for using forward contracts