Your firm is a U.K.-based importer of bicycles.You have placed an order with an Italian firm for €1,000,000 worth of bicycles.Payment (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 months 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 months 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 months 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

A)Go short 100 12-month euro futures contracts; and short 80 12-month pound futures contracts. B)Go long 100 12-month euro futures contracts; and long 80 12-month pound futures contracts. C)Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts. D)Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts. E)none of the options

Question

Your firm is a U.K.-based importer of bicycles.You have placed an order with an Italian firm for €1,000,000 worth of bicycles.Payment (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 months 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 months 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 months 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

A)Go short 100 12-month euro futures contracts; and short 80 12-month pound futures contracts. B)Go long 100 12-month euro futures contracts; and long 80 12-month pound futures contracts. C)Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts. D)Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts. E)none of the options

Quizplus · Accepted Answer

As the importer has a long position in euros, they should use the long position in euro futures contracts to hedge their exchange rate risk. In this case, going long 100 12-month euro futures contracts will allow the importer to lock in the current exchange rate for the euro and eliminate the risk of the euro depreciating against pound in the next 12 months. To offset the cost of the euro futures contract, the importer can take a short position in pound futures contracts. However, the importer only needs to short 80 12-month pound futures contracts as the value of the euro and pound should move in opposite directions, so a smaller position in pound futures contracts is required.

Your Firm Is a U