Page 200 - AFM Integrated Workbook STUDENT S18-J19
P. 200
Chapter 10
Question 2
Assume that it is now 1 October.
Tomtom Co, a UK based company, is expecting to receive 5 million Clearland
dollars (C$) in five months’ time on 28 February.
The financial manager has decided to use futures contracts to hedge against
possible fluctuations in the exchange rate.
Futures prices (£... to C$1), contract size C$100,000:
December contracts 0.5750
March contracts 0.5600
The spot rate of exchange is £0.5800 to C$1.
Required:
Calculate the result of the relevant futures hedge, assuming that the spot
rate of exchange is £0.5930 to C$1 on 28 February, and that basis
reduces to zero in a linear manner.
Solution
Set up hedge
Buy or sell futures? CC is C$. We are selling C$. So sell futures.
Number of contracts = C$5,000,000/C$100,000 = 50
Which expiry date? March, since it expires soonest after the transaction date of
28 February.
Contact the exchange: We need to sell 50 March contracts at a price of
£0.5600 to C$1.
Result of hedge
On 28 February – assume spot rate is £0.5930 to C$1 and futures price is
£0.5897 to C$1 (see W1):
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