Madrigal Electromotive US is planning to sell an air-filtered system to the fast

Question

Madrigal Electromotive US is planning to sell an air-filtered system to the fast food chain Chicken Brothers UK for the expansion of its operation in Europe. The buyer (Chicken Brothers) agreed to pay 105,000,000 pounds one year after signing the contract. Today the spot rate is $1.5930 per pound and the future rate is $1.5915 per pound. Madrigal Electromotive expects in one year a spot rate of $1.5430 and future exchange rate of $1.5415. Knowing that the British pounds future contracts are for 62,500 pounds, explain your strategy for hedging the position of Madrigal Electromotive US against changes in the exchange rate of dollar to pounds.

Explanation / Answer

Here 105,000,000 pounds are going to be received after one year, hence Madrigal Electromotive US faces he risk that the us dollar might depreciate or pound might appreciate

To hedge this risk on should buy future contract on pounds

No of contract to be purchased = 105000000/62500

=1680 contracts

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