Question

Scenario: On April 2, 2018, a Texas exporter shipped 43,000 pounds of frozen chicken quarters to a Mexican importer at a price of $1.39/lb. The exporter has agreed getting paid on June 2 in Mexican Pesos (MXP) but using April 2nd exchange rates.

Currently, the spot and June futures MXPUSD exchange rates are as follows:

Apr 2 Spot: $0.0549/MXP Apr 2 Jun Futures: $0.0542/MXP

Given that on June 2, the spot MXPUSD rate is $0.0562/MXP and the June Futures rate is $0.0558/MXP, what are the results of the exporter’s spot market transaction and hedge. Please round to the nearest U.S. dollar?

Did the hedge work as planned? Why or why not?

When negotiating the sale, what could the exporter have insisted on that, if agreed on, would have avoided the need for the exporter to hedge? How would this have impacted the importer?

Answer 1

Hi,

Given:

• Texas based exporter currently has an exposure to receive $59770 (43000 * $1.39/lb) worth of frozen chicken in MXN.

Spot market transaction results (Apr2 spot) = $0.0549/MXN

Hedge results (Sell June 2nd futures @ $0.0542\MXN) = ($0.0542 -$0.0558 ) = - $0.0016/MXN loss on futures.

Both transactions combined together would result in $0.0533/MXN (Note there is no contract size given here so Im following this method). Instead of receiving payment @ $0.0549/MXN the exporter will receive a payment worth $0.0533/MXN

Did the hedge worked as planned?

No, the hedge didnt work as planned. Hedge is supposed to limit downside fall and also eliminate any upside (lock the rate), but here is this case the locked rate was lesser than the spot itself.. Meaning instead of hedging and getting paid @$0.0533/MXN he could have directly got paid @ spot $0.0549/MXN which is more profitable. In this case hedge just makes his situation even more worse.

When negotiating the sale, what could the exporter have insisted on that, if agreed on, would have avoided the need for the exporter to hedge? How would this have impacted the importer?

When negotiating a sale the exporter should have insisted on getting paid using June2nd spot @$0.0562/MXP instead of Apr 2 spot of $0.0549/MXP.

If the June2 Spot was agreed to be paid then the importer would have incurred loss of ( $0.0549 -$0.0562) = - $0.0013/MXN loss, but the guy was wise enough to make an agreement with Apr 2 spot.

Note:

There is no contract size given in this problem for the future, if you require the real P/L (to match with your answer key) just multiply the above FX rates * Contract size * $59770 to get the exact nos.