Introduction to Corporate Finance

23: Introduction to Financial Risk Management

FIGURE 23.4 PAYOFF DIAGRAM FOR THE BUYER OF A SIX-MONTH FORWARD CONTRACT ON THE BRITISH POUND

Spot rate for

the British

pound (US$)

US$0.0491

0

US$1.6354 US$1.6845

Payoff per British pound (US$)

FIGURE 23.5 PAYOFF DIAGRAM FOR THE SELLER OF A SIX-MONTH FORWARD CONTRACT ON THE BRITISH POUND

Spot rate for

the British

pound (US$)

0

US$1.6354

US$1.6845

–US$0.0491

Payoff per British pound (US$)

£1 in six months, at a price of US$1.6354 (or effectively to buy US$1.6354 at a cost of £1). The

x-axis of these diagrams represents possible spot rates for the British pound on the settlement date

(six months in the future). The y-axis represents the profit or loss to the parties involved in the

transaction. The buyer’s profit is the spot rate for the British pound on the settlement date minus

the forward rate.