Question

A US firm is receiving 7m EUR in 3 months’ time. EUR Futures are available on the Chicago Mercantile Exchange (CME) with a contract size of 125,000 Euros and currently trade at 1.15 EUR/USD. The contract maintenance margin is 2300 USD with an initial margin of 110% of the maintenance margin.

1. a) Does the firm have a long or short foreign currency exposure?

2. b) In order to hedge does the firm need to buy or sell Futures contracts?

3. c) How many contract positions should be entered in to?

4. d) What will be the initial futures cash flow required?

5. e) Assuming that the exposure and contract maturity dates are the same, what is the expected

total net USD cashflow? (You may ignore the time value of money) Show all workings.

Answer 1

I will be able to answer first 3 questions only:

a. The Company is going to receive the Euros and they would need to sell the euros in order to get USD. But here the contract given is in terms of Dollar so for 1 dollar you give you get 1.15 euros but in this case we need dollars and receive the euros. So we will sell this contract thus implying that we are selling 1.15 euros for a dollar. Thus the firm has long foreign currency exposure and to mitigate it needs to take short currency position.

b. In order to hedge the risk the firm needs to sell the future contracts

c. One contract size is 125000 Euros thus to hedge 7,000,000 then we need 7000000/125000 = 56 contracts