Item11 Item 11 Your firm is a U.K.-based exporter of bicycles. You have sold an order...

Item11

Item 11

Your firm is a U.K.-based exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity.

			U.S. $ equiv.				Currency per U.S. $
Contract Size		Country	Tuesday		Monday		Tuesday		Monday
£	10,000	Britain (pound)	$	1.9600	$	1.9400	£	0.5102	£	0.5155
		1 month forward	$	1.9700	$	1.9500	£	0.5076	£	0.5128
		3 months forward	$	1.9800	$	1.9600	£	0.5051	£	0.5102
		6 months forward	$	1.9900	$	1.9700	£	0.5025	£	0.5076
		12 months forward	$	2.0000	$	1.9800	£	0.5000	£	0.5051
€	10,000	Euro	$	1.5600	$	1.5400	€	0.6410	€	0.6494
		1 month forward	$	1.5700	$	1.5500	€	0.6369	€	0.6452
		3 months forward	$	1.5800	$	1.5600	€	0.6329	€	0.6410
		6 months forward	$	1.5900	$	1.5700	€	0.6289	€	0.6369
		12 months forward	$	1.6000	$	1.5800	€	0.6250	€	0.6329
SFr.	10,000	Swiss franc	$	0.9200	$	0.9000	SFr.	1.0870	SFr.	1.1111
		1 month forward	$	0.9400	$	0.9200	SFr.	1.0638	SFr.	1.0870
		3 months forward	$	0.9600	$	0.9400	SFr.	1.0417	SFr.	1.0638
		6 months forward	$	0.9800	$	0.9600	SFr.	1.0204	SFr.	1.0417
		12 months forward	$	1.0000	$	0.9800	SFr.	1.0000	SFr.	1.0204

Multiple Choice

Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.
Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts.
none of the options
Go short 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.
Go long 100 12-month euro futures contracts; and long 80 12-month pound futures contracts.

Expert Solution

Answer: Option "2" is correct that says, "Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts".

Currency forward contract- It is an agreement between two parties to lock in an exchange rate on the day when contract is being signed for a future transaction. Currency forward contracts are trading Over the counter.

Currency Futures contract- It is an agreement to exchange one currency for another on a specified date in the future at a specified exchange rate. These are traded on exchange.

Hedging- It is a strategy to minimize risk of traders and investors. This is used with the help of derivatives. Example: Forward, futures and options.

Explanation- In this question, U.K based exporter will get the payment in EURO in future, the firm wants to hedge its position from any future losses, it is afraid of EURO, the rate may come down, it wants to lock in the exchange rate to lock in the profit. So it will sell (convert) EURO and buy Pound so if the exchange rate moves against them, they will not have to worry about the profits.

Contract size of EURO: 1000000 / 10000 = 100

jeff jeffy answered 1 year ago

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