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t can be assumed that the date today is 1 March 2016. It is expected that...

t can be assumed that the date today is 1 March 2016. It is expected that Lirio Co will receive Euro (€) 20 million in three months’ time from the sale of its investment. The € has continued to remain weak, while the $ has continued to remain strong through 2015 and the start of 2016. The financial press has also reported that there may be a permanent shift in the €/$ exchange rate, with firms facing economic exposure. Lirio Co has decided to hedge the € receipt using one of currency forward contracts, currency futures contracts or currency options contracts. The following exchange contracts and rates are available to Lirio Co. $ Per €1 Spot rates $1·1585 – $1·1618 Three-month forward rates $1·1559 – $1·1601 Currency futures (contract size $125,000, quotation: € per $1) March futures €0·8638 June futures €0·8656 In the above scenario, what rate we would use in order to find out the amount that will be received on the date of transaction, i.e. in three months’ time?

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Expert Solution

Determination of rates to be used
Lirio Co.has Euro receivablein 3 months time.It has the risk of Euro depreciating against USD or the risk of USD appreciating against Euro.
Rate to be used for forward contract
The quotation of forward rateis given in direct quote i.e. USD/Euro.Therefore to hedge risk of Euro depreciating we will sell Forward contract
the bid rate for forward contract is $1.1559
the ask rate for forward contract is $1.1601
Since we have to sell Euro after 3 months,We will enter the forward contract At BID PRICE of $1.1559/Euro to sell Euro 20million after 3 months
Rate to be used for future contract
Future contracts are given in indirect quote i.e. Euro/USD.Therefore to hedge the risk of buy future contract.
Future contracts are given for the month march end and june end.
Today is march 1 and we will receive Euro in 3 months time.Therefore we will sell future contract for the month of june
We will sell future contract @ Euro 0.8656
If you have any doubt,please ask
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jeff jeffy answered 1 year ago
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