5.6. USING THE FORWARD RATE IN COMMERCIAL, FINANCIAL AND ACCOUNTING
DECISIONS 209
True, the operating profit does depend on the initial valuation of theA/R, but
there is an offsetting effect in the capital gain/loss when the accounting value is
confronted with the amount actually received:^18
usingSt= 0. 90 usingFt= 0. 88- att:
A/R 2,250 2,200
COGS 1,500 1,500
operating income 750 700 - atT:
bank 2,300 2,300
A/R 2,250 2,200
capital gain/loss 50 100
5.6.2 The Forward Rate as the Intelligent Salesperson’s Guide
For similar reasons, the forward rate should also be used as the planning equivalent in
commercial decisions. Let us use the same data as before, except that the production
cost is 2,210. If the “spot” valuation convention is followed, a neophyte sales officer
may think that this is a profitable deal. It isn’t: the Equivalenthcamount ofnzd
2.5m is 2, 5 × 0 .88 = 2,200, not 2,250 as the spot translation would seem to have
implied.
Some cerebrally under-endowed employees may think that the valuation differ-
ence is the cost of hedging, but you should know better by now. The acid test again
is that the value 2,200 can be locked in at no cost, while you would have had to
pay about 50 (minus a smallpv-ing correction) for a non-standard forward contract
(sellnzd2,500 at 0.90 instead of at the market forward rate, 0.88). That is, locking
in a value of 2,250 would cost you 50 atT, implying that the true future value is
2,200.
5.6.3 The Forward Rate as the IntelligentCFO’sGuide
Lastly, in taking financing decisions we can always use the forward rate to produce
certainty equivalents forfc-denominated service payments. The principle has been
explained before. Theceqidea or, equivalently, the zero-initial-value property of a
forward deal, imply that no value is added or lost by replacing a loan by another
one in a different currency.
(^18) Note that while what I show below looks like accounting entries to the untrained eye, it violates
all kinds of accounting rules and conventions. For instance, one does not immediately calculate and
recognize the profit when a sale is made. Still, you can interpret it as aCEO’s secret private calcu-
lations of profits and losses from this transaction; and it does convey the gist of what accountants
ultimately do with this deal.