US importer will purchase 500 Italian sport cars on the 15th of FEB, APR, JUL and OCT of 2014. The price is fixed at EUR40,000/car. 4.1 What is the risk born by the US importer? 4.2 In a time table, using notations, describe how to open a strip hedge based on 0.8 hedge ratio, given that one EUR futures is for the delivery of EUR125,000.
| Date | Qty*Price | Amount | Hedge Ratio | Hedged Value | Future Strips | |||||||
| 15 February 2014 | 500*40000 | = | 200,00,000.00 | 0.8 | 200,00,000*0.8 | = | 160,00,000 | 160,00,000/125,000 | = | 128 | ||
| 15 April 2014 | 500*40000 | = | 200,00,000.00 | 0.8 | 200,00,000*0.8 | = | 160,00,000 | 160,00,000/125,000 | = | 128 | ||
| 15 July 2014 | 500*40000 | = | 200,00,000.00 | 0.8 | 200,00,000*0.8 | = | 160,00,000 | 160,00,000/125,000 | = | 128 | ||
| 15 October 2014 | 500*40000 | = | 200,00,000.00 | 0.8 | 200,00,000*0.8 | = | 160,00,000 | 160,00,000/125,000 | = | 128 | ||
| As the price per car is fixed at EUR 40,000/- US importer has fx rate risk. Suppose if EUR appreciates compared to USD then importer has to pay more USDs to its counterparty. |
| For example at the time of purchase EUR to USF is 1.1 i.e you have to pay 1.1 USD for exchange of 1 EURO so you would be end up paying 40,000*1.1=44,000 USD |
| But, If EUR Appreciates and EUR to USD exchange rate changes to 1.2 then importer would end up paying more USD i.e. 40,000*1.2=48,000 USD |
| Hence to avoid paying more because of currency fluctuations importer needs to hedge his position. |
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