A U.S. FI wishes to hedge a €10,000,000 loan using euro currency futures. Each euro futures contract is for 125,000 euros, and the hedge ratio is 1.40. The loan is payable in one year in euros.
-What type of currency hedge is necessary to protect the FI from exchange rate risk?

Question

Quizplus · Accepted Answer

To hedge the currency risk of the loan, the FI needs to sell euro currency futures. The hedge ratio of 1.40 means that the FI needs to sell 14 futures contracts (10,000,000 euros / 125,000 euros per contract / 1.40 hedge ratio). This will protect the FI from potential losses due to unfavorable movements in the euro exchange rate over the next year. Financing the loan with either euro or Eurodollar deposits would not directly hedge the currency risk and would not provide the same level of protection as selling euro currency futures.

A US FI Wishes to Hedge a €10,000,000 Loan Using Euro