ACCA AFM Syllabus E. Treasury And Advanced Risk Management Techniques - Currency Futures - calculation - Notes ^{8 / 13}

Example - Extract from the exam June 11

Casasophia Co, based in a European country that uses the Euro (€) is due to receive the payment of US$20 million in four months.

Spot rate $ per €1:
US$1·3585–US$1·3618

Currency Futures (Contract size €125,000, Quotation: US$ per €1)

2-month expiry 1•3633
5-month expiry 1•3698

Required:

Advise Casasophia Co on an appropriate hedging strategy for the US$ income it is due to receive in four months.

• Solution

  For a US$ receipt, the five-month futures contracts (two-month is too short for the required hedge period) need be bought.

  The contract will be closed out in 4 months.

  Predicted futures rate = 1•3698 – (1/3 x (1•3698 – 1•3633)) = 1•3676 (when the five-month contract is closed out in four months’ time)

  Why did I use 1/3?
  Because the change between 2-month expiry and 5-month expiry is 3 months. Therefore 1 month represents 1/3, and therefore we have deducted 1 month from 5-month expiry  option to get the predicted rate in 4th month.

  Expected receipt = US$20,000,000/1•3676 = €14,624,159

  Number of contracts to be bought = €14,624,159/€125,000 = 117 contracts

• [OR: Futures lock-in rate may be estimated from the spot and five-month futures rate:

  1•3698 – (1/5 x (1•3698 – 1•3618)) = 1•3682

  Note:
  Casasophia Co will have $20m and the bank will buy them from it. Therefore the bank BUYS HIGH and therefore the spot rate $1.3618 per €1 is used.

  US$20,000,000/1•3682 = €14,617,746

  €14,617,746/€125,000 = 116•9 or 117 contracts (a slight over-hedge)]