Question

Considering margin requirements and the daily settlements of profits and losses on a futures contract, a U. S. based hedger who plans to hedge a future cash inflow of British pounds would prefer to hedge by selling British pound futures contracts rather than selling British pound forward contracts, if the correlation between changes in the spot price of British pounds and changes in the U. S. interest rate is 0.85.

Select one:

True

False

Answer 1

True

correlation being 0.85 means there is positive relation between the two both moving in the same direction. Therefore for future cash inflows, selling british pound future contracts is better than selling british pound forward contract (where strike price is fixed) correlation being positive.

If there is increase in interest rate of US so correlation being positive and high there will be an increase in prices of british pounds at exchange and therefore there will be high cash inflows on selling of british pound futures.

If there is a decrease in interest rate of US, hedger can take loan at decreased rate for cash inflows at future date and without selling any british pound futures.