You have bid for a possible export order that would provide a cash inflow of ?1 million in six months. The spot exchange rate is $1.2375 = ?1 and the six-month forward rate is $1.2318 = ?1. There are two sources of uncertainty: (1) the euro could appreciate or depreciate and (2) you may or may not receive the export order. Illustrate in each case the final payoffs if (a) you sell one million euros forward, and (b) you buy a six-month option to sell euros with an exercise price of $1.2318/?.
(a) you sell one million euros forward
Under forward contract, no matter whether I will receive or not receive the export order, I have to sell one million euros. If I do not receive the export order, I will have to buy euros at the spot rate and sell at the forward rate. If I receive the export order, instead of selling at the spot rate, I will have to sell at ...
This solution is comprised of a detailed explanation to illustrate in each case the final payoffs for forward and option transaction.