26: Chapter Derivatives and Hedging Risk
26.1 a. A forward contract is an arrangement calling for the future delivery of an asset at an agreedupon price. b. A futures contract obliges traders to purchase or sell an asset at an agreed-upon price on a specified future date. The long position is held by the trader who commits to purchase. The short position is held by the trader who commits to sell. Futures differ from forward contracts in their standardization, exchange trading, margin requirements, and daily settling (marking to market). 26.2 1. Futures contracts are standardized and traded on exchanges, while forward contracts are tailor-made to suit the specific needs of two counterparties. The standardization of contracts increases the liquidity of futures markets in comparison to forward markets and also allows traders to enter into their positions with a certain degree of anonymity. 2. The holder of a futures contract is insulated from default risk due to clearing corporations and margin requirements. The owner of a forward contract has no guarantee that his counterparty will not default, and therefore forward holders must carefully evaluate each others credit risk before entering into a contract. 3. Since futures positions are marked-to-market at the close of trading, gains and losses on futures positions are realized daily, while gains or losses on a forward contract are not realized until the delivery of the asset. 26.3 a. i. Since the futures price of wheat is $3.10 per bushel at the end of trading on March 18, the delivery price on that date is $3.10 per bushel.
ii. On the delivery date, the long and short positions in a futures contract transact with the clearing corporation at the current futures price. Therefore, you will pay the current futures price of $3.10 per barrel in order to receive the wheat. The difference between the price that you pay at delivery and the price at which you entered into the contract is reconciled by daily marked-to-market gains and losses. iii. On March 15, you entered into a long futures position in wheat at a price of $3.00 per bushel. Since the closing futures price is $3.03 per bushel, your account receives a cash inflow of $0.03 at the end of the day. Your position in wheat futures increases to $3.03 per bushel (= $3.00 + $0.03). On March 16, your opening long position in wheat futures is $3.03 per bushel. Since the closing futures price is $3.08 per bushel, your account receives a cash inflow of $0.05 at the end of the day. Your position in wheat futures increases to $3.08 per bushel (= $3.00 + $0.03 + $0.05). On March 17, your opening long position in wheat futures is $3.08 per bushel. Since the closing futures price is $3.12 per bushel, your account receives a cash inflow of $0.04 at the end of the day. Your position in wheat futures increases to $3.12 per bushel (= $3.00 + $0.03 + $0.05 + $0.04). On March 18, your opening long position in wheat futures is $3.12 per bushel. Since the closing futures price is $3.10 per bushel, your account experiences a cash outflow of
Answers to End-of-Chapter Problems B-382
$0.02 at the end of the day. Your position in wheat futures decreases to $3.10 per bushel (= $3.00 + $0.03 + $0.05 + $0.04 - $0.02). Since you receive a notice of delivery on this date, you will pay the $3.10 futures price and receive 1 bushel of wheat. iv. The following is a summary of your futures position:
March March March March March 15 16 17 18 18 Futures Price Increases to $3.03 per bushel Futures Price Increases to $3.08 per bushel Futures Price Increases to $3.12 per bushel Futures Price Decreases to $3.10 per bushel Pay Futures Price of $3.10 at Delivery Total Net Cash Flow $0.03 $0.05 $0.04 -$0.02 -$3.10 -$3.00
Therefore, the net amount that you pay for one bushel of wheat is $3.00 per bushel. b. i. Since the futures price wheat is $2.98 per bushel at the end of trading on March 18, the delivery price on that date is $2.98 per bushel.
ii. On the delivery date, the long and short positions in a futures contract transact with the clearing corporation at the current futures price. Therefore, you will pay the current futures price of $2.98 per barrel in order to receive the wheat. The difference between the price that you pay at delivery and the price at which you entered into the contract is reconciled by daily marked-to-market gains and losses. iii. On March 15, you entered into a long futures position in wheat at a price of $3.00 per bushel. Since the closing futures price is $3.03 per bushel, your account receives a cash inflow of $0.03 at the end of the day. Your position in wheat futures increases to $3.03 per bushel (= $3.00 + $0.03). On March 16, your opening long position in wheat futures is $3.03 per bushel. Since the closing futures price is $3.08 per bushel, your account receives a cash inflow of $0.05 at the end of the day. Your position in wheat futures increases to $3.08 per bushel (= $3.00 + $0.03 + $0.05). On March 17, your opening long position in wheat futures is $3.08 per bushel. Since the closing futures price is $3.12 per bushel, your account receives a cash inflow of $0.04 at the end of the day. Your position in wheat futures increases to $3.12 per bushel (= $3.00 + $0.03 + $0.05 + $0.04). On March 18, your opening long position in wheat futures is $3.12 per bushel. Since the closing futures price is $3.10 per bushel, your account experiences a cash outflow of $0.02 at the end of the day. Your position in wheat futures decreases to $3.10 per bushel (= $3.00 + $0.03 + $0.05 + $0.04 - $0.02). On March 19, your opening long position in wheat futures was $3.10 per bushel. Since the closing futures price is $2.98 per bushel, you will experience a cash outflow of $0.12 at the end of the day. Your position in wheat futures decreases to $2.98 per bushel (= $3.00 + $0.03 + $0.05 + $0.04 - $0.02 - $0.12). Since you will receive a notice of delivery on this date, you will pay the $2.98 futures price and receive 1 bushel of wheat.
Answers to End-of-Chapter Problems B-383
Notice that even though you only paid $2.98 for the delivery of wheat, the net amount that you paid for it out of your pocket is $3.00 per bushel, the futures price at which you originally entered into the position. iv. The following is a summary of your futures position:
Event March March March March March March March 15 15 16 17 18 19 19 Enter into Long Futures Positon at $3.00 per bushel Futures Price Increases to $3.03 per bushel Futures Price Increases to $3.08 per bushel Futures Price Increases to $3.12 per bushel Futures Price Decreases to $3.10 per bushel Futures Price Decreases to $2.98 per bushel Pay Futures Price of $24.98 at Delivery Total Net Cash Flow Cash Flow None $0.03 $0.05 $0.04 -$0.02 -$0.12 -$2.98 -$3.00
Therefore, the net amount that you pay for one bushel of wheat is $3.00 per bushel. 26.4 a. The forward price of an asset with no carrying costs or convenience value is: Forward Price = S0(1+ r) where S0 = the current price of the underlying asset r = the interest rate between the initiation of the forward contract and the delivery date Since you will receive the bonds face value of $1,000 in 11 years and the 11-year spot interest rate is currently 8% per annum, the current price of the bond is $428.88 [= $1,000 / (1.08)11 ]. Since the forward contract defers delivery of the bond for one year, the appropriate interest rate to use in the forward pricing equation is the one-year spot interest rate of 3%: Forward Price = $428.88(1.03) = $441.75 Therefore, the forward price of your contract is $441.75. b. If both the 1-year and 11-year spot interest rates unexpectedly shift downward by 2%, the appropriate interest rates to use when pricing the bond is 6% per annum (EAY), and the appropriate interest rate to use in the forward pricing equation is 1% per annum (EAY). Given these changes, the current price of the bond increases to $526.79 [= $1,000 / (1.06)11]. The new forward price of the contract is: Forward Price = $526.79(1.01) = $532.06 Therefore, the forward price of an otherwise identical contract will increase to $532.06 given the unexpected change in the 1-year and 11-year spot interest rates.
Answers to End-of-Chapter Problems B-384
26.5
a. You would create a short position by selling futures contracts. b. A short position reduces your overall risk if you are hurt by decreases in the price of the underlying asset. For example, if you are selling oil in one year at the spot price, you will make less money if the price of oil falls over the next year. In order to hedge this risk, you should sell oil futures contracts that expire in approximately one year. c. You would create a long position by purchasing futures contracts. d. A long position reduces your overall risk if you are hurt by increases in the price of the underlying asset. For example, if you are planning to purchase oil in one year at the spot price, you will have to pay more for the oil if the spot price increases over the next year. In order to hedge this risk, you should buy oil futures contracts that expire in approximately one year.
26.6
If Mark Fisher believes that the futures price of silver will fall over the next month, he should take on a short position in silver futures contracts with approximately one month until expiration. By selling futures contracts now, he will be locking in a sales price that is higher than what he believes he will be able to purchase silver futures for in one months time. William Santiago is a little nave about the capabilities of hedging. While hedging can significantly reduce the risk of changes in foreign exchange markets, it cannot completely eliminate it. Basis risk is the primary reason that hedging cannot reduce 100% of any firms exposure to price fluctuations. Basis risk arises when the price movements of the hedging instrument do not perfectly match the price movements of the asset being hedged. Textbook p. 766: The coupon payment is not specified in the question. Hence, the most reasonable assumption is to use a zero-coupon bond. Also, in part b, 9.83 should be 4.8 and 10.13 should be 5.1. a. The forward price of an asset with no carrying costs or convenience value is: Forward Price = S0(1+ r) where S0 = the current price of the underlying asset r = the interest rate between the initiation of the forward contract and the delivery date Forward Price = + 1,000(1.048) /1.0522 = $ 946.96 Therefore, the forward price of your contract is $ 946.96. b. It is important to remember that 100 basis points equals 1% and one basis point equals 0.01%. Therefore, if all rates increase by 30 basis points, each rate increases by 0.003. The new 18-month spot rate (EAY) is 0.055 (= 0.0520 + 0.003), and the new 6-month spot rate (EAY) is 0.051 (= 0.048 + 0.003). Bond price = $ + 1,000 (1.051) /1.0552 = $ 944.27
26.7
26.8
Answers to End-of-Chapter Problems
B-385
Therefore, the forward price of an otherwise identical contract is $ 944.27 given the 30 basis point increase in all semiannual rates.
26.9
Let r equal the interest rate between the initiation of the contract and the delivery of the asset.
Cash Flows From Strategy 1 Today -S0 +S0 0 1 Year --S0(1+r) -S0(1+r)
Purchase Silver Borrow Total Cash Flow Cash Flows from Strategy 2
Purchase Silver Forward Total Cash Flow
Today -0
1 Year -f -f
Notice that each strategy results in the ownership of silver in one year for no cash outflow today. Since the payoffs from both the strategies are identical, the two strategies must cost the same in order to preclude arbitrage. The forward price (f) of a contract on an asset with no carrying costs or convenience value equals the current spot price of the asset (S0) multiplied by 1 plus the appropriate interest rate between the initiation of the contract and the delivery date of the asset. Therefore, f must equal S0(1+r). 26.10 Kevin will be hurt if the yen loses value relative to the dollar over the next eight months. Depreciation in the yen relative to the dollar results in a decrease in the yen / dollar exchange rate. Since Kevin is hurt by a decrease in the exchange rate, he should take on a short position in yen per dollar futures contracts in order to hedge his risk. a. Your former roommates annual mortgage payments form a 20-year annuity, discounted at the long-term interest rate of 8%. Solve for the payment amount so that the present value of the annuity equals $300,000, the amount of principal that your former roommate plans to borrow. $300,000 = C * A200.08 C = $30,556 Therefore, your former roommates annual mortgage payment will be $30,556 b. The most significant risk that you face is interest rate risk. If the current market rate of interest rises between today and the date that you meet with the president of MAX, the fair value of the mortgage will decrease, and the president will only be willing to
Answers to End-of-Chapter Problems B-386
26.11
purchase the mortgage from you for a price less than $300,000. If this is the case, you will not be able to loan your former roommate the full $300,000 that you promised her. c. Treasury bond prices have an inverse relationship with interest rates. As interest rates rise, Treasury bonds become less valuable; as interest rates fall, Treasury bonds become more valuable. Since you are hurt when interest rates rise, you are also hurt when Treasury bonds decrease in value. In order to protect yourself from decreases in the price of Treasury bonds, you should take a short position in Treasury bond futures to hedge his interest rate risk. Since three-month Treasury bond futures contracts are available and each contract is for $100,000 of T-bonds, you would take a short position in three 3month Treasury bond futures contracts in order to hedge your $300,000 exposure to changes in the market interest rate over the next three months d. i. If the market interest rate is 10% on the date that you meet with the president of MAX, the fair value of the mortgage equals an annuity that makes annual payments of $ 30,556 for 20 years, discounted at 10%. Mortgage Value= $30,556A200.10 = $260,140 Therefore, MAXs president will be willing to pay you $260,140 for the mortgage if the market interest rate is 10% on the date of your meeting. ii. An increase in the interest rate will cause the value of the T-bond futures contracts to decrease. iii. You will make money on your short position in the T-bond futures contracts if interest rates rise. e. Textbook p. 767 part e: 9 percent should be 7 percent. i. If the market interest rate is 7% on the date that you meet with the president of MAX, the fair value of the mortgage equals an annuity that makes annual of payments $ 30,556 for 20 years, discounted at 7%. Mortgage Value= $30,556A200.07 = $323,711 Therefore, MAXs president will be willing to pay you $323,711 for the mortgage if the market interest rate is 7% on the date of your meeting. ii. A decrease in the interest rate will cause the value of the T-bond futures contracts to increase. iii. You will lose money on your short position in the T-bond futures contracts if interest rates fall. 26.12 a. The price of a bond equals the present value of its cash flows. Price of Bond A = $1,000 / (1.11) Price of Bond B = $1,000 / (1.11)5 = $593.45 Price of Bond C = $1,000 / (1.11)10 = $352.18
Answers to End-of-Chapter Problems
= $900.90
B-387
b. If the market rate of interest increases to 14% per annum, the price of each bond will be: Price of Bond A = $1,000 / (1.14) Price of Bond B = $1,000 / (1.14)5 = $519.37 Price of Bond C = $1,000 / (1.14)10 = $269.74 = $877.19
c. The percentage change in the price of each bond is calculated as follows: Percentage Change in Bond Price = (New Price / Old Price) 1 Percentage Change in Bond A = ($877.19 / $900.90) 1 = -2.63% = ($519.37 / $593.45) 1 = -12.48% = ($269.74 / $352.18) 1 = -23.41%
Percentage Change in Bond B
Percentage Change in Bond C
Therefore, Bond C experienced the greatest percentage change in price. 26.13 a. The price of a bond equals the present value of its cash flows. Since Bond A pays an annual coupon of 7%, the bonds owner will receive $70 (= 0.07 * $1,000) at the end of each year in addition to the bonds $1,000 face value when the bond matures at the end of year 4.. Price of Bond A = $70 / 1.10 + $70 / (1.10)2 + $70 / (1.10)3 + $1,070 / (1.10)4 = $904.90 The price of Bond A is $904.90. Since Bond B pays an annual coupon of 11%, the bonds owner will receive $110 (= 0.11 * $1,000) at the end of each year in addition to the bonds $1,000 face value when the bond matures at the end of year 4. Price of Bond B = $110 / 1.10 + $110 / (1.10)2 + $110 / (1.10)3 + $1,110 / (1.10)4 = $1,031.70 The price of Bond B is $1,031.70. The duration of a bond is the average time to payment of the bonds cash flows, weighted by the ratio of the present value of each payment to the price of the bond. The relative value of each payment is the present value of the payment divided by the price of the bond. The contribution of each payment to the duration of the bond is the relative value of the payment multiplied by the amount of time (in years) until the payment occurs.
Answers to End-of-Chapter Problems
B-388
Bond A
Payment $70 $70 $70 $1,070 PV of Payment $63.64 $57.85 $52.59 $730.82 Relative Value 0.0703 0.0639 0.0581 0.8076 Time to Payment (in years) 1 2 3 4 Duration 0.0703 0.1279 0.1744 3.2305 3.6031
The duration of Bond A is 3.6031 years.
Bond B
Payment $110 $110 $110 $1,110 PV of Payment $100.00 $90.91 $82.64 $758.14 Relative Value 0.0969 0.0881 0.0801 0.7349 Time to Payment (in years) 1 2 3 4 Duration 0.0969 0.1762 0.2403 2.9394 3.4529
The duration of Bond B is 3.4529 years. b. If the market interest rate decreases to 7% per annum: Price of Bond A= $70 / 1.07 + $70 / (1.07)2 + $70 / (1.07)3 + $1,070 / (1.07)4 = $1,000 Price of Bond B = $110 / 1.07 + $110 / (1.07)2 + $110 / (1.07)3 + $1,110 / (1.07)4 = $1,135.49 c. Bond A should experience a greater percentage change in its price. Bond A has a higher duration than Bond B since a larger proportion of its payments occur in later years. Bonds with higher durations will experience greater percentage changes in price for a given movement in the interest rate. d. The percentage change in the price of each bond is: Percentage Change in Bond Price = (New Price / Old Price) 1 Percentage Change in Bond A = ($1,000 / $904.90) 1 = 10.51% = ($1,135.49 / $1,031.70) 1 = 10.06%
Percentage Change in Bond B
26.14
The duration of a bond is the average time to payment of the bonds cash flows, weighted by the ratio of the present value of each payment to the price of the bond. Since the bond is selling at par, the market interest rate must equal 9%, the annual coupon rate on the bond. The price of a bond selling at par is equal to its face value. Therefore, the price of this bond is $1,000.
Answers to End-of-Chapter Problems
B-389
The relative value of each payment is the present value of the payment divided by the price of the bond. The contribution of each payment to the duration of the bond is the relative value of the payment multiplied by the amount of time (in years) until the payment occurs.
Payment $90 $90 $1,090 PV of Payment $82.57 $75.75 $841.68 Relative Value 0.0826 0.0758 0.8417 Time to Payment (in years) 1 2 3 Duration 0.0826 0.1515 2.5250 2.7591
Therefore, the duration of the bond is 2.7591 years. 26.15 The duration of a bond is the average time to payment of the bonds cash flows, weighted by the ratio of the present value of each payment to the price of the bond. Since the bond is selling at par, the market interest rate must equal 9%, the annual coupon rate on the bond. The price of a bond selling at par is equal to its face value. Therefore, the price of this bond is $1,000. The relative value of each payment is the present value of the payment divided by the price of the bond. The contribution of each payment to the duration of the bond is the relative value of the payment multiplied by the amount of time (in years) until the payment occurs.
Payment $90 $90 $90 $1,090 PV of Payment $82.57 $75.75 $69.50 $772.18 Relative Value 0.0826 0.0758 0.0695 0.7722 Time to Payment (in years) 1 2 3 4 Duration 0.0826 0.1515 0.2085 3.0887 3.5313
Therefore, the duration of the bond is 3.5313 years. 26.16 The duration of a bond is the average timing of the bonds cash flows, weighted by the ratio of the present value of each payment to the price of the bond. In order to determine the duration of a bond, first calculate the bonds price. Since this bond pays an annual coupon of 5%, the bonds owner will receive $50 (= 0.05 * $1,000) at the end of each year in addition to the bonds $1,000 face value at the end of year 4. Use the market interest rate of 9% per annum to discount the bonds cash flows. Price of Bond = $50 / 1.09 + $50 / (1.09)2 + $50 / (1.09)3 + $1,050 / (1.09)4 = $870.41 Next, set up the following table to calculate the bonds duration. The relative value of each payment is the present value of the payment divided by the price of the bond. The contribution of each payment to the duration of the bond is the relative value of the payment multiplied by the amount of time (in years) until the payment occurs. Therefore, the duration of the bond is 3.7009 years.
Answers to End-of-Chapter Problems B-390
26.17
The duration of a liability is the average time to payment of the cash flows required to retire the liability, weighted by the ratio of the present value of each payment to the present value of all payments related to the liability. In order to determine the duration of a liability, first calculate the present value of all the payments required to retire it. Since the Hansels plan to pay $20,000 at the beginning of each year for four years, the present value of these payments can be calculated using the annuity formula. Use the market interest rate of 15% to discount these payments. PV(College Payments two years from today) = = $20,000A40.15 $57,100
The annuity formula yields the present value of the college payments one year prior to the initial payment. Since the first payment will occur three years from today, discount this amount must by two years in order to find its present value. PV(College Payments) = = $57,100 / (1.15)2 $43,176
Therefore, the present value of the Hansels college payments is $43,176. Next, set up the following table to calculate the liabilitys duration. The relative value of each payment is the present value of the payment divided by the present value of the entire liability. The contribution of each payment to the duration of the entire liability is the relative value of the payment multiplied by the amount of time (in years) until the payment occurs.
Payment $20,000 $20,000 $20,000 $20,000 PV of Payment $13,150.32 $11,435.06 $9,943.53 $8,646.55 Relative Value 0.3046 0.2648 0.2303 0.2003 Time to Payment (in years) 3 4 5 6 Duration 0.9137 1.0594 1.1515 1.2016 4.3262
Therefore, the duration of the Hansels liability is 4.3262 years. 26.18 The duration of a portfolio of assets or liabilities is the weighted average of the duration of the portfolios individual items, weighted by their relative market values. a. The total market value of Blue Steels assets is $1,255 million (= $43 + $615 + $345 + $55 + $197). The relative market value and duration of each asset is listed below. The relative value of each asset is the market value of the asset divided by the market value of all the banks assets.
Relative Value 0.0343 0.4900 0.2749 0.0438 0.1570 Duration (in years) 0 0.33 0.75 5 15
Federal Funds Deposits Accounts Receivable Short-Term Loans Long-Term Loans Mortagages
Answers to End-of-Chapter Problems
B-391
Since the duration of a group of assets is the weighted average of the durations of each individual asset in the group, the duration of Blue Steels assets is: Duration of Assets =(0.0343)(0) + (0.4900)(0.33) + (0.2749)(0.75) + (0.0438)(5) + (0.1570)(15) = 2.94 Therefore, the duration of Blue Steels assets is 2.94 years. b. The total market value of Blue Steels liabilities is $1,110 million (= $490 + $370 + $250). The relative market value and duration of each liability is listed below. The relative value of each liability is the market value of the liability divided by the market value of all the banks liabilities.
Relative Value 0.4414 0.3333 0.2252 Duration (in years) 0 1.5 10
Checking and Savings Deposits Certificates of Deposit Long-Term Financing
Since the duration of a group of liabilities is the weighted average of the durations of each individual liability in the group, the duration of Blue Steels liabilities is: Duration of Liabilities = = (0.4414)(0) + (0.3333)(1.5) + (0.2252)(10) 2.75
Therefore, the duration of Blue Steels liabilities is 2.75 years. c. Since the duration of Blue Steels assets does not equal the duration of its liabilities, the bank is not immune from interest rate risk. 26.19 The duration of a portfolio of assets or liabilities is the weighted average of the duration of the portfolios individual items, weighted by their relative market values. a. The total market value of Magnums assets is $1,800 million (= $100 + $500 + $1,200). The relative market value and duration of each asset is listed below. The relative value of each asset is the market value of the asset divided by the market value of all the banks assets.
Overnight Money Loans Mortgages Relative Value 0.0556 0.2778 0.6667 Duration (in years) 0 1 12
Since the duration of a group of assets is the weighted average of the durations of each individual asset in the group, the duration of Magnums assets is: Duration of Assets = =(0.0556)(0) + (0.2778)(1) + (0.6667)(12) 8.28
Therefore, the duration of Magnums assets is 8.28 years.
Answers to End-of-Chapter Problems
B-392
b. The total market value of Magnums liabilities is $1,200 million (= $300 + $400 + $500). The relative market value and duration of each liability is listed below. The relative value of each liability is the market value of the liability divided by the market value of all the banks liabilities.
Relative Value 0.2500 0.3333 0.4167 Duration (in years) 0 1.1 19
Checking and Savings Accounts Certificates of Deposit Long-Term Debt
Since the duration of a group of liabilities is the weighted average of the durations of each individual liability in the group, the duration of Magnums liabilities is: Duration of Liabilities = = (0.2500)(0) + (0.3333)(1.1) + (0.4167)(19) 8.28
Therefore, the duration of Magnums liabilities is 8.28 years. c. The duration of Magnums assets equals the duration of its liabilities. However, the bank is still not immune from interest rate risk since the value of its assets is greater than the value of its liabilities. Duration matching only eliminates risk if the value of the firms assets equals the value of the firms liabilities. 26.20 a. Yes, there is an opportunity for the Miller Company and the Edwards Company to benefit from a swap. Miller wishes to borrow at a floating rate but has a comparative advantage in the fixed rate market, while Edwards would like to borrow at a fixed rate but has a comparative advantage in the floating rate market.
Miller Edwards Fixed Rate 10% 15% Floating Rate LIBOR + 3% LIBOR + 2%
b. Since Miller would prefer to borrow at the lowest floating rate available and Edwards would like to borrow at the lowest fixed rate available, the following swap would benefit both parties: 1. Miller borrows at the fixed rate of 10%. 2. Edwards borrows at the floating rate of LIBOR + 2%. 3. The two companies enter into an interest-rate swap in which Edwards agrees to make Millers fixed rate payments and Miller agrees to make Edwards floating rate payments. 26.21 a. The companys net exposure is a net inflow of Euros of 750,000. The pension payment of 250,000 is fixed, but the net profits of 1,000,000 can vary based on seasonality and the economic conations. b. Forward contract The company should sell a forward contract on 750,000, due in one month since the company is concerned about a decrease in the value of the Euros.
Answers to End-of-Chapter Problems
B-393
Futures contract Again the company should sell futures contracts for 750,000, due in one month since the company is concerned about a decrease in the value of the Euros. Currency swaps The company will enter into an agreement to swap 750,000 for US$609,756 ( 750,000 / 1.23) in one month. Currency futures options The Company will buy a put option to sell 750,000 one month from now. c. With a forward contract, the company must settle the contract, and therefore, if it does not receive enough euros, then it will have to buy them at the spot price. With a futures contract, the contract must be settled daily, and the contract could be sold if the amount of net euros actually received did not agree to the contract. With a currency swap, again, the company must pay the exact amount of the swap, so if the amount is not know, this becomes riskier. For options, the company can let the options expire and not settle the amount. Therefore, if not enough euros were received, then the company could exercise some of the options and let others expire. d. If the company is going to hedge all of their euros, then they must sell 6 contracts to total 750,000 (750,000/125,000).
Answers to End-of-Chapter Problems
B-394