International Business Assessment 2022

Assessment 3 1
International Business: Assessment 3
By Student’s Name
Name of Class and Course
Professor
Name of the University
City and State
The Date

Assessment 3 2
Question 1:
1. Definition of a forward exchange contract
A forward exchange contract refers to an agreement between two parties (buyer and bank) to
exchange two currencies at a predetermined exchange rate at a future date. A forward
exchange contract is used to mitigate foreign exchange risks. Buyers use this type of
contracts to protect themselves against transactional losses arising from the fluctuation of
foreign exchange rates. Forward exchange rates are predetermined 30 days, 90 days, to up to
twelve months into the future (Richards, 2015, p. 56). In some cases, a foreign exchange rate
can last for ten years in the future where the U.S dollar and the Euro currencies are involved.
A forward exchange rate is calculated using four key variables, namely:
a) The spot rate; (S)
b) The interest rate of the domestic currency; (r(d)).
c) Interest rate of the foreign currency; (r(f)).
d) t= Contract time in days.
Therefore, a forward exchange rate is calculated using the formula;
Forward rate (F)= S X
2. Explain why would you like to use this protection (no more than 300 words) - 10
marks
Several factors determine the exchange rates between two different currencies. Some of the
elements are; inflation rate, interest rates, political stability, country’s balance of payments,
government debts, terms of trade, recession and speculations. Any change in these factors
would positively and negatively impact a foreign exchange rate (Wystup, 2017, p. 202).

Assessment 3 3
Surprisingly, all these factors are macro, meaning businesses cannot control them. For
instance, a business trading U.S based company is likely to pay more than the contract
amount if the dollar weakens against the Euro (Hull, 2009, p. 412). On the other hand, the
same business would pay less than the contract amount if the dollar strengthens against the
Euro.
The illustration mentioned above clearly shows that the amount payable in the future date is
likely to fluctuate about the changes in the foreign exchange rate. The forward exchange
contract is a tool used by businesses to avoid losses in case a domestic currency weakens
against a foreign currency used in trade (Wystup, 2017, p. 316).
As a Polish manufacturer of leather goods, I should enter into a forward exchange contract
with my bank. The contract will ensure that the business does not suffer losses in case of an
exchange rate risk. Therefore, I would hedge against currency movements to ensure that my £
500,000 does not lose value.
3. Calculating the one-month forward exchange rate
A forward exchange rate is calculated using the formula;
Forward rate (F)= S X
The spot rate (S) is calculated by dividing the Euro’s exchange rate with the Great Britain
Pound’s exchange rate. Therefore, the spot rate is calculated, as shown below.
S= €/ £
S= 1.1128/ 1.1152
S= 0.9978