Question

In: Finance

it is July 2006 and you expect to receive ZAR 1 000 000 in October 2006...

it is July 2006 and you expect to receive ZAR 1 000 000 in October 2006 from a customer. While you believe that the $ will weaken in the next 3 months, you do not want to take chances, and therefore wish to hedge against the risk of a strengthening $. You gather the following information about the foreign currency and futures markets.

spot exchange rate                                                       $1.7640 per ZAR

Forecast spot rate in October                                        $1.7400 per ZAR

Contract size                                                                   ZAR 62500

Quoted spot buying price for October futures                $1.7310 par ZAR

Quoted spot selling price for October futures                 $1.7420 per ZAR

a) calculate the number of futures contracts you will buy or sell.

b) show how you can hedge against currency risk using the futures market hedge, assuming that in October 2006, you can close or cancel a short position at a price of $1.6890 per ZAR and a long position at a price of $1.6600 per ZAR and the forecast spot rate for October turned out to be the actual spot rate in October.

Solutions

Expert Solution

a) calculate the number of futures contracts you will buy or sell.

Since I am receiving foreign currency (ZAR), I will short / sell the future contracts on ZAR. This will ensure my $ price for selling ZAR is locked.

Number of future contracts I will sell = Exposure / Contract size = ZAR 1,000,000 / ZAR 62,500 = 16

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b) show how you can hedge against currency risk using the futures market hedge, assuming that in October 2006, you can close or cancel a short position at a price of $1.6890 per ZAR and a long position at a price of $1.6600 per ZAR and the forecast spot rate for October turned out to be the actual spot rate in October.

Quoted spot selling price for October futures                 $1.7420 per ZAR

Since, i have locked in the price, irrespective of what happens, I will sell the ZAR at $ 1.7420 and end up getting $1.7420 x 1,000,000 = $ 1,742,000

jeff jeffy answered 2 years ago
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