A Nigerian importer must pay €150,000 for a shipment that will arrive in three months. The current spot exchange rate is ₦480 per euro, and the 3‑month forward rate quoted by the bank is ₦485 per euro.

If the importer waits for the spot rate, the future spot rate is uncertain: there is a 60 % chance it will be ₦470 per euro and a 40 % chance it will be ₦495 per euro.

Calculate the expected cost in Naira if the importer chooses (i) to lock in the forward contract, and (ii) to wait for the spot rate. Which option has the lower expected cost?

Question

A Nigerian importer must pay €150,000 for a shipment that will arrive in three months. The current spot exchange rate is ₦480 per euro, and the 3‑month forward rate quoted by the bank is ₦485 per euro.

If the importer waits for the spot rate, the future spot rate is uncertain: there is a 60 % chance it will be ₦470 per euro and a 40 % chance it will be ₦495 per euro.

Calculate the expected cost in Naira if the importer chooses (i) to lock in the forward contract, and (ii) to wait for the spot rate. Which option has the lower expected cost?

Accepted Answer

Forward: ₦72,750,000; Expected spot: ₦72,000,000; Spot expected to be cheaper

Neco Model Questions Vol1 2022 Commerce Question 29

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