A US importer, who incurs costs in Euros and bills its customers in USD, is conc

Question

A US importer, who incurs costs in Euros and bills its customers in USD, is concerned about the depreciation of USD against Euro due to EURO payables of 25,000,000 in a month. To hedge (protect himself/herself) the position, importer decides to use futures markets. Currently EUR contracts (125,000 EUR each) are traded at 1.3725. Spot rate is 1.3615 (i.e. 1.3615 USD per 1 EUR). Suppose the exporter takes an equal futures position to its cash market position (Euro 25m) at 1.3725. Assume that futures contract price and spot rates are 1.3755 and 1.3745 respectively when the hedge is liquidated. What should be the unit cost per EURO for the exporter in terms of USD?

1.3525

1.3945

1.3600

1.3715

1.3525

1.3945

1.3600

1.3715

Explanation / Answer

Answer-

Current Future Price=1.3725

Cuurent Spot Price=1.3615

Exposure is Payble 25 million EURO,

To hedge in Future importer has to Sell EURO at Spot Price and Buy Future Contract. On expiry date sell future contract to settle position.

Gain on Future=1.3755-1.3725=.003 per Euro

Buy Spot to Pay Customer at 1.3745

Net Cost =Spot price

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