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Looking back on the entire situation (i.e., the original transaction and the forward contract) in terms of the US$ needed to settle both transactions, did entering the forward contract work out well for Townshend Company?

Looking back on the entire situation (i.e., the original transaction and the forward contract) in terms of the US$ needed to settle both transactions, did entering the forward contract work out well for Townshend Company?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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**Case Study: Townshend Company's Forward Contract** **Transaction Overview:** Townshend Company sold guitars to The Who Inc. for £250,000 on September 21, 2020. The collection of payment from The Who, Inc. is due on December 19, 2020. Additionally, on September 21, Townshend entered into a 90-day forward contract to sell £250,000 at a rate of £1 = $1.23. This forward contract was entered into to manage the exposed net asset position in UK Pounds, but it was not designated as a hedge. The spot rates were: - 09/21/20: £1 = $1.21 - 12/20/20: £1 = $1.24 **Evaluation:** Looking back at the entire situation (i.e., the original transaction and the forward contract) in terms of the US dollars needed to settle both transactions, did entering the forward contract work out well for Townshend Company? - (O) **A)** Yes. Without the forward contract, the company would have received fewer US dollars when selling the pounds on the settlement date. **Explanation:** If the company had not entered into the forward contract and instead sold the £250,000 at the spot rate on December 19, 2020, they would have received fewer US dollars due to the change in the exchange rates. The forward contract rate of £1 = $1.23 was more favorable than the spot rate on 12/20/20 of £1 = $1.24, thus benefiting Townshend Company.
Transcribed Image Text:**Case Study: Townshend Company's Forward Contract** **Transaction Overview:** Townshend Company sold guitars to The Who Inc. for £250,000 on September 21, 2020. The collection of payment from The Who, Inc. is due on December 19, 2020. Additionally, on September 21, Townshend entered into a 90-day forward contract to sell £250,000 at a rate of £1 = $1.23. This forward contract was entered into to manage the exposed net asset position in UK Pounds, but it was not designated as a hedge. The spot rates were: - 09/21/20: £1 = $1.21 - 12/20/20: £1 = $1.24 **Evaluation:** Looking back at the entire situation (i.e., the original transaction and the forward contract) in terms of the US dollars needed to settle both transactions, did entering the forward contract work out well for Townshend Company? - (O) **A)** Yes. Without the forward contract, the company would have received fewer US dollars when selling the pounds on the settlement date. **Explanation:** If the company had not entered into the forward contract and instead sold the £250,000 at the spot rate on December 19, 2020, they would have received fewer US dollars due to the change in the exchange rates. The forward contract rate of £1 = $1.23 was more favorable than the spot rate on 12/20/20 of £1 = $1.24, thus benefiting Townshend Company.
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