Question

On March 3rd, Ford agrees to import auto parts worth 10.5 million euros from Germany. The parts will be delivered Sept. 5th and are payable immediately in euros. Ford decides to hedge its euro position by entering into IMM futures contracts. The euro futures contract is for 125,000 euros and goes into delivery on Sept. 17th. The March 3rd spot rate is $0.545/euro, and the March 3rd September futures price is $0.555/euro. On Sept. 5th, the spot rate turns out to be $0.557, while the Sept. futures price is $0.5565. How many futures contracts does Ford need to hedge its exchange-rate risk and should it buy or sell futures contracts on March 3rd?

84 contracts, buy 52 contracts, sell 84 contracts, sell 52 contracts, buy

Answer 1

Number of futures to hedge the risk = amount payable / size of each futures contract

Number of futures to hedge the risk = 10.5 million / 125,000 ==> 84 contracts

The payable amount is in Euros. So, dollars need to be exchanged into Euros on Sept. 5th. That is, Ford will sell dollars and buy euros. the futures contracts are based in euros (dollars per euro). hence to hedge the currency risk, Ford should buy the futures contract. The futures contract would make a profit if the exchange rate of dollars per Euro rises, and make a loss if the exchange rate of dollars per Euro falls. The profit or loss from futures contract would offset the change in spot exchange rate.