Question

In March, a US pension fund manager is long German government bonds. She’s due to receive €2.5m in fixed coupons in June but is concerned about a weaker euro outlook. She needs to be sure about the USD value of the coupons because of the liabilities in the fund. The June euro currency future is 1.3865. Using examples of possible future spot levels in euro/dollar, describe fully how the fund manager can use the currency future to hedge her FX exposure.   

Answer 1

Since the US fund manager is long (Purchased) German government bonds,she is afraid of Euro falling against Dollar.Therefore in order to hedge the risk she need to sell June euro currency futures.
June euro currency future = $1.3865 per Euro
Amount due to be received = Euro2.5 million
Total amount to be received in June by selling currency futures = 2,500,000*1.3865 = $3,466,250
Let us take different possible Future spot in June for Euro/dollar and calculate our position when we hedge by selling June euro currency futures in march at $1.3865 per euro
(a)	(b)	(.c)	(d)	(e.)=c*d	(f)=b*d	(g)=e+f
Selling rate of contract	Possible spot rate	Profit/(loss) per Euro	Total amount(In euro)	Total profit/loss (In dollars)	Converting Euro 2.5 m into dollars	Net Payoff
	(Euro/Dollar)
1.3865	1.4	-0.0135	2,500,000	-33750	3,500,000	3,466,250
1.3865	1.35	0.0365	2,500,000	91250	3,375,000	3,466,250
1.3865	1.3	0.0865	2,500,000	216250	3,250,000	3,466,250
1.3865	1.25	0.1365	2,500,000	341250	3,125,000	3,466,250
Since Payoff is same in all the cases,we can say the position is hedged using currency futures.
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