Currency Forwards

CFA Level I Derivatives
#1

Gemco expects to receive EUR50 million three months from now and enters into a cash settlement currency forward to exchange these euros for U.S.dollars at USD1.23 per euro.If the market exchange rate is USD1.25 per euro at settlement,what is the amount of the payment to be received or paid by Gemco?

I understand the payment is $1mill, but I dont understand why Schweser says that Gemco should be paying the counterparty $1m. Or rather, I have trouble in determining who should pay who in this example!

#2

If Gemco converts EUR 50M to USD at 1.23 rate, it will get USD 50*1.23= 61.5M (this is forward contract)

If Gemco converts EUR 50M to USD at 1.25 rate, it will get USD 50*1.25=62.5M (this is what Gemco would have gotten if not in forward aggrement.)

Meaning, GEMCO has lost USD 1M by getting into forward agreement. so they should be paying.

Makes sense?

#3

It’s going to receive Euros, so to hedge it sells Euros in the forward market, USD is the price currency EUR is base. USD/EUR rises that is to say the value of their liability rises.

#4

Thanks guys, makes sense. All this study is giving me tunnel vision.