True or false: The cost or benefit of hedging foreign exchange risk when a firm is selling the foreign currency forward is accurately measured by the forward discount or premium on the foreign currency

What will be an ideal response?

We know that if the firm sells the foreign currency in the forward market when the foreign currency is at a discount, it will generate less domestic currency revenue than if the foreign currency had been sold at the spot rate. But, the important point is that the cash flows are in the future. They cannot be valued directly with the spot rate because the spot rate is for current cash flows or the present values of foreign currency amounts. When the foreign currency is at a discount, we know that the foreign currency interest rate is higher than the domestic currency interest rate. Thus, we must use this high foreign currency interest rate to get a present value if we are going to use the spot rate to value the cash flow. Alternatively, we can convert the foreign currency into domestic currency in the forward market and then discount it to the present with the domestic interest rate. In either case, we end up with the same amount of domestic currency if covered interest rate parity is satisfied. Thus, a forward discount does not represent a true cost of hedging, and, by analogy, a forward premium does not supply a benefit to hedging.