You are the U.S. distributor of a line of German home appliances. You have order

Question

You are the U.S. distributor of a line of German home appliances. You have ordered 5000 dishwashers at a f.o.b. price of 325 Euros per dishwasher. Under the terms of the purchase agreement, payment is due in 90 days. The spot $/Euro exchange rate is $1.35/Euro. 90-day FX futures contracts for 125,000 Euros are currently selling at $1.36/Euro. You wish to hedge your exposure.

(a) Will you go long or short the futures contract?

(b) How many contracts will you use?

(c) Compute your gain or loss on the combined position if at delivery the spot $/Euro exchange rate is:

i. $1.30

ii. $1.35

iii. $1.40.

Explanation / Answer

amount of sale = 5000*325 = 1625000 euros a) future contract is higher dollar/euro, so, seller (a USA company) will go long to be certain to get more dollars than at present exchange rate. (ANSWER) b) No. of contracts = 1625000/125000 = 13 (ANSWER) c) i) As at delivery date, exchange rate is $1.3/euro, lower than future ex. rate of $1.36/euro, there will be gain of = (1.36 - 1.30)*1625000 = 97500 ($) (ANSWER) ii) Gain = (1.36-1.35)*1625000 = 16250 ($) (ANSWER) iii) Loss = (1.40 - 1.36)*1625000 = 65000 ($) (ANSWER)

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