Question

1. You recently sold some goods to an importer in Switzerland and, during the negotiations, you agreed to invoice the goods in francs, knowing that you will need to convert the francs to dollars upon receipt. The current exchange rate is $.60 per franc, and the invoice will be for 250,000 francs. Payment is due in 60 days. You decide to hedge your exposure using futures contracts.

a) How many futures contracts will you need?

b) Will you create a buy hedge or a sell hedge?

c) What will your spot market position be if the spot exchange rate is $.70 in 60 days?

2. A treasury manager is assessing the annual performance of the firm’s short-term investment portfolio. The beginning value of the portfolio was $5,200,000. At year-end, the portfolio was valued at $5,350,000. No investments were purchased over the year as revenues and cash flows dropped, which made it difficult to accumulate additional cash holdings.

a) What is the annual rate of return on the short-term investment portfolio?

b)What would the annual rate of return be if the ending value equaled $5,100,000?

Answer 1

1. The contract size of Franc (CHF)/USD is 125,000 Swiss Franc.

The amount needs to be Hedged is Franc 250,000, Hence no of Contracts required is 2.

(b)The payment to be received is in CHF and hence CHFUSD Contract should be sold to convert CHF into USD.

(c) When Contract is hedged Spot market Rate is CHF USD = 0.60, that is for each CHF is sold the seller gets 0.60 USD, however after 60 days CHF USD = 0.70, , that is for each CHF is sold the seller gets 0.70 USD. Had the seller not hedged CHF, he would get more USD. Hence , the exporter is at loss.

However, this ignore CHF USD Interest rate, in case there is interest rate differential the hedge rate shall be different.

1. Value of Portfolio = USD 5,200,000

At the Year END, Value of Portfolio = USD 5,350,000

1. The return on portfolio is USD 150,000;

Annual Return = [ (5,350,000/5,200,000)^{^1/1}-1 ] x100 = (1.029-1)x100 =2.9%

1. The return on portfolio is USD -100,000;

Annual Return = [ (5,100,000/5,200,000)^{^1/1}-1 ] x100 = (0.981-1)x100

= -1.9%

The Treasury manger makes a loss.