Q50032 NP and Co. has imported goods for US $ 7,00,000.

NP and Co. has imported goods for US $ 7,00,000. The amount is payable after three months. The company has also exported goods for US $ 4,50,000 and this amount is receivable in two months. For receivable amount a forward contract is already taken at € 48.40. The market rates for € and $ are as under.

Spot                     € 48.50 / 70

Two months       25 / 30 points

Three months    40 / 45 points

The Company wants to cover the risk and it has two options as under :

1. To cover payables in the forward market and
2. To lag the receivables by one month and cover the risk only for the net amount. No interest for delaying the receivables is earned. Evaluate both the options if the cost of Rupee Funds is 12%. Which option is preferable?

Solution

• To cover payable and receivable in forward Market                                                    

Amount payable after 3 months                    $7,00,000

Forward Rate                                                    Rs. 48.45

Thus Payable Amount (Rs.) (A)                      Rs. 3,39,15,000

Amount receivable after 2 months                  $ 4,50,000

Forward Rate                                                    Rs. 48.40

Thus Receivable Amount (Rs.) (B)                  Rs. 2,17,80,000

Interest @ 12% p.a. for 1 month (C)                Rs. 2,17,800

Net Amount Payable in (Rs.) (A) – (B) – (C)        Rs. 1,19,17,200

• Assuming that since the forward contract for receivable was already booked it shall be cancelled if we lag the receivables. Accordingly any profit/ loss on cancellation of contract shall also be calculated and shall be adjusted as follows:

Since net payable amount is least in case of second option, hence the company should lag receivables.

Note: In the question it has not been clearly mentioned that whether quotes given for 2 and 3 months (in points terms) are premium points or direct quotes. Although above solution is based on the assumption that these are direct quotes, but students can also consider them as premium points and solve the question accordingly.

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