3. You would like to hedge your accounts payable due one-year from now of Indian

Question

3. You would like to hedge your accounts payable due one-year from now of Indian Rupees (IR) 10 million in the Futures market. But there are no Futures contract available on Indian Rupees. However, Futures contract on Singapore dollar (S$) and Hong Kong dollar (HK$) are available. On running regressions to observe their correlations, you found the following:

RIR = 0.05 + 1.1 x Rhk$ with R2 = 0.75

RIR = 0.04 + 1.3 x Rs$ with R2 = 0.90

Spot Rates for currencies are: $0.02/IR, $0.10/HK$, $0.40/S$. Contract Sizes: HK$200,000 S$50,000 a) Which is the best futures contract (HK$ or S$) to hedge your accounts payable of Indian Rupees with? b) How many futures contracts do you need? Do you go short or long?

Explanation / Answer

a) The best future contract will be Singapore Dollar as the Correlation between Indian Ruppee & Singapore Dollar is higher(1.3) as compd. to that of Hong Kong Dollar.

b) We will have to long on 10 Singapore Dollar Contracts. This is because:-

We have Payable of IR 10 million i.e. 10,000,000.

Equivalent Singapore Dollar amount will be = 10,000,000*Spot Rate(IR)/Spot Rate S$= 10,000,000*0.02/0.4= 500,000 H$.

Since each contract size is S$ 50,000 So no. of Future Contracts required will be 500,000/50,000= 10 contracts.

The reason we are going long is that we have an obligation to pay 10 million IR 1 year from now so we want to secure ourself from any unexpected rise in the Rupee Value so we will agree to buy equivalent amount of S$ 1 year from now thus going long on the contract.

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