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

The MXPUSD December futures contracts are available in denominations of MXP500,000 and are settled on June 18, 2018. What would be the exporter’s strategy to hedge as much of the exchange rate risk as possible and what does the exporter expect the result to be?

Is this a perfect hedge? Why or why not?

Answer 1

HERE, TEXAS EXPORTER HAS EXPORTED GOODS TO MEXICAN IMPORTER.

HE WILL RECEIVE MONEY IN MXP

THE LOSS WILL HAPPEN TO EXPORTER WHEN MXP DEPRECIATES OR DOLLAR PRRECIATES

The spot and futures rate shows that MXP appreciates, so he can enter into futures contract today to fix dollar receivables

so strategy is to enter into futures contract

43000 x $1.39 = $ 59770, equivalent to MXP = $59770/0.0549 =MXP1088706.74 which means he has to buy 2 futures contract

if he enters into futures contract, the rate applicable is $0.0542/MXP

in that case, amount to be received in future contract on expiry = MXP1000000 for $54900

MXP1000000 = any depreciation happens to MXP will not affect the exporter

so he can hedge at most $54900 only, remaining $4870 are unhedged

now if things goes as exporter expects, he will have loss to the extent, MXP88706.74

which is equal to MXP 88706.74 (0.0549-0.0542) = $62.09 loss

this is not a perfect hedge, as some of the MXP can not be hedged for $

Go through it, Any doubts, please feel free to ask, Give positive feedback, Thank you