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FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

Question

The euro/US dollar currency future is a contract for €125,000. It is priced in US dollars, and the tick size is $0.0001.

Currency futures are not normally used by companies to hedge currency risks. However, assume that a Canadian company intends to use currency futures to hedge the following currency exposure.

It is now February. The Canadian company has to make a payment of US $640,000 in May to a supplier.

The price of June euro/US dollar futures is currently 1.2800.

The company is concerned that the value of the dollar will increase in the next few months, and it therefore decides to use futures to hedge the exposure to currency risk.

Required

(a) How should the company hedge its currency risk with futures?

(b) Suppose that in May when the company must make the payment in dollars, the June futures price is 1.2690 and the spot rate (US$/€1) is 1.2710.

Show what will happen when the futures position is closed, and calculate the effective exchange rate that the company has obtained for the US $640,000

Answer

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Tags: Basis risk, Currency futures, Effective Exchange Rate, Foreign Exchange Risk, Futures contracts, Hedging
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

Question

Zest Inc. is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in YEN and will total 140 million yen.
The managing director of Zest Inc. wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:
Spot foreign exchange rate $1 = 128.15 yen
Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
Contract size 12,500,000 yen, contract prices are US$ per yen.
Contract prices:
September 0.007985
December 0.008250
Assume that futures contracts mature at the end of the month.

Required:
(a) Illustrate how Zest Inc. might hedge its foreign exchange risk using currency futures.

(b) Assuming spot exchange rate is 120 yen / $1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur.

Answer

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Tags: Basis risk, Currency futures, Foreign Exchange Risk, Hedge efficiency, Hedging, Japan, USA, Yen, YSL
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

Question

AB Enterprises, a company whose domestic currency is the cedi, has imported a consignment of tomato paste from Spain at a cost of EUR540,000, which is payable in three months’ time. Ama Kofi, the company’s finance director, is concerned about the company’s exposure to currency risk, and she is considering the use of forward contracts or currency futures to hedge the risk.

Required:
(i) Explain to Ama Kofi FOUR differences between a forward contract and a futures contract.
(ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AB Enterprises facing in relation to the EUR540,000 tomato paste consignment?
(iii) Explain to Ama Kofi, THREE disadvantages of hedging the euro exposure with futures hedge.

Answer

Find Related Questions by Tags, levels, etc.

Tags: Basis risk, Currency Risk, Financial instruments, Forward contracts, Futures contracts, Futures hedging, Hedging, Transaction risk
Level: Level 2

Topic: Futures and hedging with futures

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FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

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FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

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FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

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FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

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