Suppose you are a consultant living in the United States and have been engaged by a French company to perform a market study, which should take 18 monthes to complete. They are planning to pay you 100,000 francs monthly. The current exchange rate is $0.20 per franc. You are concerned that the French Franc will strengthen versus the dollar and that you will receive fewer U.S dollars each month. The French company does not want to have to come up with dollars to pay you each month and is not willing to agree to a fixed exchange rate of $0.20 per franc.
a) How could you use swap contracts and financial intermediary to eliminate your risk?
b) Suppose that in the sixth month, the spot price of the franc is $0.18. Without the swap contract, what would be your cash revenues in dollars? With the swap contract what will they be?
c) Suppose that in the tenth month, the spot price of the franc is $0.25. Without the swap contract, what would be your cash revenues in dollars? with the swap contract what will they be?
I can approach a financial intermediary and offer to enter into a swap ...
This solution identifies the correct answer and shows step-by-step calculations to show the effect of swap contracts with a fixed exchange rate.