Brazilian real hedging with futures The US dollar (USD) to Brazilian real (BRL)
ID: 2613013 • Letter: B
Question
Brazilian real hedging with futures
The US dollar (USD) to Brazilian real (BRL) exchange rate was 0.5793 USD/ BRL on October 21, 2010. By January 17, 2011 it had moved to 0.5934 USD/ BRL. Over the same time-period, BRL 3-month futures had moved from 0.5826 USD/ BRL. Assume the maturity date of this BRL futures contract to be December 21, 2010.
1. If your organization imported goods worth 0.5 million BRL, how many BRL futures contracts will be needed for hedging against currency risk? {Assume each BRL futures contract has a face-value of 100,000 BRL}
2. Describe the futures hedging strategy. What is the outcome of the 3-month hedging strategy that you have implemented?
Explanation / Answer
Exchange rate on 21st October 2010 S1 = USD 0.5793 / BRL
Exchange Rate on 17th January 2011 S2 = USD 0.5934 / BRL
3-Month Future Exchange rate 21st December 2010 F1 = USD 0.5826 / BRL
Answer (1)
Amount imported = BRL 0.50 Million = BRL 500,000
Face Value of futures contract = BRL 100,000
No of Futures contracts required = 500,000 / 100,000 = 5 contracts
As BRL 0.5 Million needed to be paid for the imports, the company needs to buy 5 contacts to receive BRL and pay for the import obligation.
Answer (2)
The company needs to buy 5 contacts to hedge (go long in BRL) for the import obligation.
Effective = Future spot price - Gain on Futures (Basis)
Basis = F1 - S1 = 0.5826 - 0.5793 = $ 0.0103 / BRL
Effective Cost = 0.5934 - 0.0103 = $ 0.5831 / BRL
By going long on futures the company can hedge its position at $ 0.5831 / BRL against the future spot price of $ 0.5934 / BRL gaining $ 0.0103 / BRL or $ 5150 on the total amount payable on imports.
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