Question

The three-month futures price for the British pound is $1.2890/₤. You expect the spot price three months from today to be $1.2560/₤. The British pound contract size is ₤62,500.

1.) If you are a speculator would you buy the futures contracts or sell them. Explain your answer.

2.) How much profit would you make if you trade 25 contracts and the expectations come true?

3.) If you were a MNC with A/R of ₤5 million due in three months, would you buy or sell the pound futures. Explain your answer.

4.) How many contracts would you buy or sell? How much would your pound A/R be worth in dollars?

Answer 1

1. As a speculator I would sell the future contracts, on the day of settlement if the spot price is 1.2560, and the settlement price is 1.2890, I can buy British pound from the market at the price of 1.2560 and sell them to the price of 1.2890.

2. Profit = 25*62500*(1.2890-1.2560) = $51562.5

3. As pound is expected to become cheaper, I would sell pound.

4. To recieve the value of 5 Million pound after three months, which will be worth of $6.28 Millions. I need to sell $6.28/1.2890 worth of 4.8719938 Milions pounds. Hence number of contracts = 4.8719938/62500 = 78 Contracts.