- 15 Marks
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.
Find Related Questions by Tags, levels, etc.
- Tags: Basis risk, Currency futures, Foreign Exchange Risk, Hedge efficiency, Hedging, Japan, USA, Yen, YSL
- Level: Level 2
