Suppose you receive 2,500,000 British Pounds (not Euros) today and plan to conve

Question

Suppose you receive 2,500,000 British Pounds (not Euros) today and plan to convert into US dollars early next February. Which is the correct action to take today in order to hedge against GBP exchange rate risk?

Short 20 British Pounds futures contracts expiring in February

Long 20 British Pounds futures contracts expiring in March

Short 40 British Pounds futures contracts expiring in March

Long 40 British Pounds futures contracts expiring in February

Short 20 British Pounds futures contracts expiring in February

Long 20 British Pounds futures contracts expiring in March

Short 40 British Pounds futures contracts expiring in March

Long 40 British Pounds futures contracts expiring in February

Explanation / Answer

Answer:

Contract size of One British Pound Futures: 62,500 British pounds

Short futures position is used a receiver of a currency to lock in a price of that currency that he is going to sell in the future.

In the given problem the no. of futures contract required to hedge the currency risk from 2,500,000 pounds is

= 2,500,000 pounds/62,500 British pounds = 40 contracts

And as he is the receiver of 2,500,000 pounds and wishes to lock in at dollar price for a pound by selling pounds in february, he should take a short position in pounds.

So he should take the postion of Short in 40 British Pounds futures contracts expiring in March. (Ans)

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