If you are doing business in the USA, and you have to pay lets say 50M euros in 3 months and you want to hedge against the exchange rate risk, would you enter into a forward rate contract of US/Euro using the bid rate or the ask rate? I thought you were buying euros so you want to use the ask rate (the higher rate) but ran into a mock exam question and said to use the bid rate because you want to “sell” euros.
Explain?
So from my understanding and please correct me if am wrong, you wanna convert dollar to euros right ? If so, then the transaction would mean that you are shorting the dollar against the euro. In this case, the hedge trade would mean to take a short position on the euro to protect against dollar appreciation. When you buy, you buy at the “ask” and when you sell, you sell at the “bid”. So if I’ve understood this correctly, you will initate a short position at the bid rate to hedge.
If you need to pay EUR 50 million in 3 months, then you need EUR 50 million in 3 months: you enter into a forward contract to buy EUR 50 million in 3 months. If the quote is USD/EUR you use the ask because you’re buying EUR. If the quote is EUR/USD then you use the bid because you’re selling USD.
Ohhh I think I read the question wrong. The question asks about the mark to market value, and starts as:
“Six months ago, a European customer placed an order for EUR 20 million of oil field construction equipment with delivery and payment scheduled to take place one year later. Nexran hedged all of its exposure to the euro by entering into a forward position at a forward price of USD1.1716/EUR.”
So the USA company isn’t buying a product with euro, they are in reciept of a payment in Euro, so that’s why they’re using the BID and the mark-market the position, I have to use the current Forward rate ASK? (All in terms of USD/EUR)