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Foreign exchange and the time value of money; Gum Tree Export Association Your members are negotiating to sell gum trees to Japan. The Japanese suggest that both parties agree the price for payments in one year's time at today's spot rate of A$1.00 = Yen 70.00 and share any gains and losses over the year 50:50.. Alternatively, the contract will be written for a fixed price at the spot rate above. What do you do? Answer: do not accept the offer to share exchange rate variations 50:50%.If you want to protect 50% of the foreign currency income against movements in the exchange rate, do it through a 'forward exchange contract' (see protection strategies) as there is a benefit to you of %5 p.a. if you do [the difference between Australian interest rates of 5.5%p.a and Japanese rates of 0.5%p.a.]. To replicate the suggested 50:50 sharing of exchange rate movements by selling 50% forward on the foreign exchange markets will give your members a benefit of A$ 53,631 per Yen 70 million of contracts. While the exchange rate for converting Yen today is 70.00, the forward exchange contract rate is at a benefit of 5%, or A$1.00 = Yen 66.50. Thus converting 50% of this total contract at the forward exchange contract rate of 66.50 instead of Yen 70.00 yields a benefit of A$ 52,631. In other words, the benefit foregone of agreeing to share 50:50 would be A$ 52,631 per A$ 1 million of exports. Note: For importers of capital or equipment, accept their offer! |