Question

1. You are to receive €350,000 on March 16. Today’s spot rate is $1.15/€. The forward rate is $1.18/€. On March 16 the spot rate is $1.14/€. Futures contracts are for €125,000 each.

Q1. How many contracts do you enter?
Q2. Do you enter contracts to buy or to sell?

On March 16you, 1) close out the forward contracts, and 2) receive the €350,000 and exchange them for dollars.

Q3. Did you make or lose money on the contracts?

Q4. How much money did you make or lose on the contracts?

Q5. When you combine the gain or loss on the futures contracts with the dollars exchanged for the €350,000 what was the effective dollar/euro total exchange rate?

Q6. Why was the amount you received per euro more than the $1.18 future contract hedge amount?

Answer 1

Q1) The number of contracts to enter is amount receivable / size of futures contract = (3,50,000 / 1,25,000) , which is 2.80. Rounding off to the nearest number, you enter into 3 futures contracts.

Q2) The US company will receive Euros and exchange them for dollars. Therefore, the US company will sell euro contracts to convert the Euros into Dollars on expiry of the contract.

Q3) The Euro has depreciated from $1.15/€ to $1.14/€. However the spot on rate on March 16 is still lower than the initial contract price of $1.18/€. As the Euros can be converted into USD at a higher rate of $1.18/€, you made money on the contracts

Q4) Money made on contracts = (Contract price - spot rate on March 16) * Contract size * 3

= (1.18 - 1.14) * 125,000 * 3, which is $15,000

Q5) Effective exchange rate = (Amount exchanged into USD at spot rate on March 16) + (Gain on futures contracts) / €350,000

Effective exchange rate = ((€350,000 * 1.14) + $15,000) / €350,000

= $1.1829/€

Q6) Amount received per Euro is more because the amount receivable (€350,000) was overhedged as we rounded off the answer in (Q1) to the nearest number. As fractional futures contracts are not available, 3 contracts are sold. The favorable currency movement and the gain in futures contracts was more proportional to the amount hedged.