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Financial Risk Management

In: Business and Management

Submitted By Jullll
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The investor is entering into a short forward contract to sell 100,000 British pounds (GBP) for U.S. dollars (USD) at an exchange rate of of 1.9000 USD per GBP, which means he/she has locked in the selling price 1.9000 USD per pound to be realized for the British pounds no matter what the exchange rate is in the market at the end of the contract. As a result, the investor will make a gain if the exchange rate goes down less than 1.9000 USD per pound, and make a loss if the exchange rate goes up more than 1.9000 USD per pound at the end of the contract, as the investor need to buy the GBP at the spot price (market price) to fulfill his/her contractual obligation. Therefore, if
a) at the end of contract, the exchange rate is 1.8900USD, the investor makes a gain 100,000 GBP*(1.9000-1.890) = 1,000 USD out of the contract.
b) at the end of the contract, the exchange rate is 1.9200USD, the investor makes a loss 100,000 GBP * (1.900-1.9200)= -2,000 USD by entering the forward contract.

Total Profit calculation as following:
Oct. 24, 2009, Sell April 2010 futures price=$0.912 per pound;
Jan.21, 2010, Close out its position at price=$0.883 per pound;
Contract size=40,000 pounds of cattle per contract
This leads to a profit of 40,000* (0.912-0.883) = $1,160
The tax treatments are different for a hedger and a speculator according to the accounting standard. If the future contract is qualified as a hedge, the gains or losses are generally recognized for accounting purposes in the period which the gains or losses from the hedged item are recognized. Therefore, the result is that: Accounting profit for tax purpose=0 for the year ended 31 Dec. 2009; the whole profit will be for tax purpose=$1,160 for…...

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