Question

General Motors (GM), a U.S.-based company, has a 20-million Euro account payable in three months for an order of engines it will purchase from a German company. Three-month Euro currency futures contracts are available at an exchange rate of $1.0785/Euro.

1. What position would GM take on those Euro currency futures contracts (long or short) and why?

2. Assuming that the spot exchange-rate for the Euro in 90 days is $1.1785/Euro, calculate and report GM's total profit or loss on the Euro currency futures contracts, and state whether it is a profit or a loss.

3. Calculate and report the dollar cost for GM to buy 20-million Euros at the spot rate of $1.1785.

4. Calculate GM's total dollar cost of the order (profit/loss on the futures contract and the cost of Euros in the spot market.)

Answer 1

1]

GM needs to buy € by paying $ in 3 months.

It needs to hedge against a rise in the $/€ exchange rate.

Therefore, GM needs to buy (long) Euro currency futures contracts

GM will buy (long) €20 million of Euro currency futures contracts

2]

profit on futures contracts = (spot rate in 3 months - futures contract purchase price) * number of €

profit on futures contracts = ($1.1785 - $1.0785) * 20,000,000

profit on futures contracts = $2,000,000

3]

Dollar cost to buy € = spot rate in 3 months * number of €

Dollar cost to buy € = $1.1785 * 20,000,000

Dollar cost to buy € = $23,570,000

4]

total dollar cost = Dollar cost to buy € - profit on futures contracts

total dollar cost = $23,570,000 - $2,000,000

total dollar cost = $21,570,000