Question

# Your firm is an Italian importer of bicycles. You have placed an order with a Swiss...

Your firm is an Italian importer of bicycles. You have placed an order with a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment (in francs) 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.
12-months Forward British Pound Contracts (£)10,000 = (\$/£)2.0000

12-months Forward Euros Contracts (€)10,000 =(\$/€) 1.6000

12-months Forward Swiss Francs Contracts (SFr)10,000 = (\$/SFr)=1.0000.

 a. Go long 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts. b. Go short 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts. c. Go long 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts. d. Go short 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts.

Solution:

In order to hedge the risk, there are following two steps needed to be taken:-

1. Go short 200 12-month Swiss franc futures contracts, which will provide with 2,000,000 Swiss Francs after 12-month period against 2,000,000 USD as the exchange rate for the futures contract is \$1 per Swiss Franc. In order to meet this contract, \$2,000,000 will be required after 12 months for which the second contract described below is required.
2. The exchange rate for Euros contract is \$1.6 per Euro. Therefore, we would require to go long 125 (i.e. 200/1.6) euro contracts which will give us \$2,000,000 (i.e. 125*10,000*1.6) after 12 months to meet the first contract.

Based on above explanations, we can see that the correct option is option d.

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