Question

**An FI is planning to hedge its one-year, 100 million
Swiss francs (SFr)–denominated loan against exchange rate risk. The
current spot rate is $1.10/SFr. A one-year SFr futures contract is
currently trading at $1.08/SFr. SFr futures are sold in
standardized units of SFr125,000.**

**Should the FI be worried about the SFr appreciating or depreciating?****Should the FI buy or sell futures to hedge against exchange rate risk exposure?****How many futures contracts should the FI buy or sell if a regression of past changes in the spot exchange rate on changes in the future exchange rate generates an estimated slope of 1.4?****Show exactly how the FI is hedged if it repatriates its principal of SFr100 million at year-end, the spot exchange rate of SFr at year-end is $1.05/SFr, and the forward exchange rate is $1.0443/SFr.**

Answer #1

a) The FI should be worried about SFr appreciating, as the loan is denominted in SFr and as the value of SFr appreciates, FI will have to make more outflow of $.

b) FI should buy futures to hedge the risk of change in exchange rate as it will be paying off SFr denominted loan.

c) No. of contracts to be bought:

(SFr 100 million/ SFr 125000) × 1.4 = 1120 contracts

d) Hedging of loss under forward cover:

$ value of loan at the time of repayment $ 105 ml

( $1.05× SFr 100 million)

Repayment under Forward cover - $ 104.43 ml

( $ 1.0443× SFr 100 million)

Hedged amount $ 0.57 ml

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