Mark to Market Value of Forward (Economics)

CFA Level II Economics
#1

Below are the texts relating to the CFAI Qbank question.

“The conversation then moves to a discussion of some recent Nexran transactions. 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.”

“Nexran has just been informed by the customer that because of the collapse in oil prices, it is canceling the order. Brannigan tells Carlisle to mark the forward position to market to facilitate exiting the currency hedge. (Exhibit 2 provides information about current FX rates and interest rates.)”

By looking at the above texts, how am I suppose to know whether Nexran entered into long or short forward contract intially? Besides, how do I know which currency is he buying or selling short in the forward contract? The above texts only mentioned “Nexran hedged all of its exposure to the euro by entering into a forward position at a forward price of USD1.1716/EUR.”
I am really confused on this particular part in the econs topic. I would really appreciate if someone is able to shed some light on this. Thanks in advance!

#2

Where is Nexran located? What is their home currency?

#3

@S2000magician According to the question, Nexran is a US manufacturer of industrial equipment, hence their home currency is USD.

#4

Therefore, what currency do they want to receive, ultimately?

What currency will they receive in one year from their customer?

What position will they take in the 1-year forward contract?

#5

@S2000magician Ultimately, they want to receive USD since it’s their home currency.
They will receive EURO in one year from their customer.
However, I couldn’t relate to what position will Nexran take in the forward contract initially to hedge its exposure. According to the solution provided, it mentioned that Nexran sold EUR20 million forward to the settlement date at 1.1716 (USD/EUR).
How does selling the EURO helps Nexran in hedging its exposure to EURO?
I would appreciate if you could explain a bit further to clear my doubt

#6

So . . . one year from today, Nexran will have EUR 20 million that it doesn’t want, and no USD that it does want. They’ll get rid of what they don’t want (i.e., sell the EUR) and take what they do want (i.e., buy the USD). That’s their forward position: sell EUR, buy USD.

It locks in the USD/EUR exchange rate, so it locks in the amount of USD that Nexran will receive.

#7

Now I understand how it works. Thanks for making it clear!

#8

My pleasure.