Question

Your firm is an Italian importer of bicycles. You have placed an order with a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment (in francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity.
12-months Forward British Pound Contracts (£)10,000 = ($/£)2.0000

12-months Forward Euros Contracts (€)10,000 =($/€) 1.6000

12-months Forward Swiss Francs Contracts (SFr)10,000 = ($/SFr)=1.0000.

a.
Go long 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts.

b.
Go short 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts.

c.
Go long 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts.

d.
Go short 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts.

Answer 1

Answer:

The answer is c.  Go long 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts

Explanation:

By doing as described in (c); the Italian importer will hedge its exchange rate risk by locking the SFr/€ at 1.60000

First, by long 200 12-month Swiss franc futures contracts, the Italian importer will have the right to buy SFR2,000,000 (10,000 x 200) at the exchange rate of $/SFr=1.0000. The cost of is $2,000,000 ( 2,000,000 x 1.0000).

Second, by short 125 12-month euro futures contracts, the Italian importer will have the right to sell €1,250,000 (10,000 x 125) at the exchange rate of $/€=1.6000. The total receipt is $2,000,000 ( 1,250,000 x 1.6).

Thus, by entering into the two Forward contracts as described above, the importer may be assured that they are able to exchange €1,250,000 for SFr2,000,000 in 12-month time; resulting in the exchange rate of SFr/€ at 1.60000.