Illustration
Problem 10
A French company imports in January equipment from the USA for $ 6 million. The
payment in US dollars is due in June. The importer fears an appreciation of US dollars.
The spot rate is $ 0.2/FFr. The FFr future contract for June is quoted at $ 0.19/FFr. What
should the French importer do? Assume further spot rate on settlement date is $
0.185/FFr and the future contract is likely to be quoted at $ 0.178/FFr. What is the
hedging efficiency?
Solution 9
The US dollar is likely to appreciate against the French francs. This also means that the
French franc would depreciate.
To guard against the depreciation of the French franc, the importer can sell French franc
future contracts. The amount involved is $ 6 million or FFr 30 million (=6 million/0.2).
Thus, the total number of future contracts to be sold is 60 (=30 million/0.5 million), since
the value of one future contract is FFr 500,000.
The French importer deposits the security amount with the Clearing House. During the
period January-June, the importer will pay margins if the FFr rises and have its account
credited if the FFr slips. On the due date in June the contract is closed (or
repurchased).Say, the spot rate on the due date is $ 0.18/FFr and the future contract is
being quoted at $ 0.178/FFr.
The importer makes a loss: FFr (6/0.2 – 6/0.185) million = FFr 2.432432 million.
However, on the future market, it makes a gain equal to $ (0.19 – 0.178) X 60 X 500,000
= $ 360,000 = FFr 360,000/0.185 = FFr 1,945,946.
Net loss = FFr 2,432,432 – 1,945,945 = FFr 486,486.Note: The loss is not fully covered as spot rate deteriorated more than the future rate.
Hedge efficiency can be defined as the ratio between the gains made on the future market
and the loss payable due to the rate movement on spot market. It is equal to
1,945,946/2,432,432 X 100 = 80 percent.
Illustration
Problem 11
A company will receive $ 5.5 million in three months (March) from now. It will like to
place this sum for six months in Euro-dollar market. The rates are likely to go down.
The current rate is 1 percent over and above that of LIBOR, which is 9 percent. Euro-
dollar 3 months interest future is quoted at 90. What can the company do?