- 10 Marks
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
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