Question

Explain how currency futures could be used to hedge your business in Mexico.

Answer 1

Use of currency futures to hedge business in Mexico.

A hedge is a strategy to protect oneself from the risk of loss duty change in exchange rate.

Situation A:

When there is receivable in Mexican Pesos in future.

Suppose you have exported goods to Mexico and 1 million MXN , Mexican pesos are receivable after one month. Assume current USD/MXN spot rate is $0.0519/MXN

Assume the current one month futures rate is $0.0520/MXN

The risk of loss due to currency appreciation of MXN can be hedge by selling MXN futures of 1 million MXN at the rate of $0.0520/MXN. This way you lock the rate at $0.0520/MXN.

Even if MXN appreciates after one month, you will receive $0.0520million

If MXN appreciates after one month to , say $0.0517/MXN,

You will receive in spot $0.0517 million at the spot rate but you will gain (0.0520-0.0517)=$0.003million in futures

Situation B:

Suppose you have imported goods worth 1 million MXN and the amount is payable after one month .

You can hedge your risk of loss due to currency rate fluctuation, by buying MXN futures at $0.0520/MXN

If the MXN depreciates and the currency rate is $0.0522 after one month , you will gain in futures by (0.0522-0.0520)=$0.002 million which will compensate same amount of loss in the spot rate