Today is May 2, and Bid and Ask are $1.2100/E and $1.2300/E. The August 21 and S

Question

Today is May 2, and Bid and Ask are $1.2100/E and $1.2300/E. The August 21 and September 20 futures contracts are priced at is $1.2500 and $1.2600 respectively. Each contract controls 100,000E. You are receiving 418,000E in Euro revenues on September 9th. Assume that currently, the September 9th forward is $1.2560.

5. How would you properly hedge the revenues using futures contracts? Discuss why, how much you will be over or under-hedged, and the risks.
a. Buy 3 August Euro-futures contracts
b. Sell 3 August Euro-futures contracts
c. Sell 4 September Euro-futures contracts
d. Buy 4 September Euro-futures contracts
e. Sell 3 September Euro-futures contracts

6. If we properly hedge the above revenue, are we over-hedged or under-hedged, and what will cause the hedge to lose money? Explain why.
a. Over-hedged, an appreciation of the Euro relative to the forward
b. Over-hedged, a depreciation of the Euro relative to the forward
c. Under-hedged, an appreciation of the Euro relative to the forward
d. Under-hedged, a depreciation of the Euro relative to the forward
e. Nothing, the hedge will work perfectly

7. If on September 9th, the Bid and Ask are $1.2490/E and $1.2540/E, and the futures price is for the September 20 contract is $1.2550, did your hedge work perfectly, or did you make or lose money on the hedge?
a. Worked Perfectly (no gain or loss greater than $100)
b. Profit < $1000
c. Loss < $1000
d. Profit > $1000
e. Loss >$1000

8. Given the above results would we have been better off over-hedging or under-hedging? Retrospectively, (using the bid-ask and futures prices in problem 7) how many futures contracts should we have bought/sold to minimize gains and losses on the hedge (minimize hedge variance)?
a. Under-hedging; sell 3 contracts
b. Under-hedging; buy 3 contracts
c. Over-hedging; buy 5 contracts
d. Over-hedging; sell 5 contracts
e. Over-hedging; sell 6 contracts






9. Suppose instead that the resulting bid and ask are $1.2590/E and $1.2610/E, and the futures price is for the September 20 contract is $1.2620, (and you hedged using the proper number of contracts

Explanation / Answer

5. c. Sell 4 September Euro-futures contracts

6. b. Over-hedged, a depreciation of the Euro relative to the forward

7.   b. Profit < $1000

8. a. Under-hedging; sell 3 contracts

9.   d. Profit > $500

10. d. Over-hedging; sell 5 contracts

11. c. Minimize variance of the hedged position

12. a. Deviations in the spot rate from the current spot

13. c. Hedging with futures, you offset gains or losses on the spot price for the currency with gains or losses on the futures position

14.   b. Approx 2%

15. a. US Bond, no

16. c. $0.003-$0.002

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