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25 August, 05:40

Your firm is a U. K.-based importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months.

Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity.

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  1. 25 August, 08:35
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    Complete question:

    Your firm is a U. K.-based importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity

    A. Go short 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.

    B. Go long 100 12-month euro futures contracts; and long 80 12-month pound futures contracts.

    C. Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.

    D. Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts. E. None of the above

    Answer:

    Go short 100, 12-month euro futures contracts; and long 80, 12-month pound futures contracts. Option c is correct.

    Explanation:

    Buy €1m (a long position) forward using futures contracts, at the 12-month forward rate of $1.60 per €1 pay

    $1,600,000 = €1,000,000 * $1.60/€1.

    At the 12-month forward rate of $2/≤this is worth ≤800,000.

    Go short pound futures contracts.

    so, Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.
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