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1 THE UNIVERSITY OF HONG KONG FACULTY OF BUSINESS AND ECONOMICS FINA0301 - DERIVATIVES Second Semester, 2008-2009 Tutorial 3 Problem Set Solution – Chapter 4 c Practice Questions Question 2 A good rule of thumb is to choose a futures contract that has a delivery month as close as possible to, but rather than, the month containing the expiration of the hedge. The contracts that should be used are therefore (a) July, (b) September, and (c) March. Question 3 The treasurer should (a) estimate the company’s future cash flows in Japanese yen and U.S. dollars and (b) enter into forward and futures contracts to lock in the exchange rate for the U.S. dollar cash flows. However, this is not the whole story. The company should examine whether the magnitudes of the foreign cash flows depend on the exchange rate. For example, will the company be able to raise the price of its product in U.S. dollars if the yen appreciates? If the company can do so, its foreign exchange exposure may be quite low. The key estimates required are those showing the overall effect on the company’s profitability of changes in the exchange rate at various times in the future. Once these estimates have been produced the company can choose between using futures and options to hedge its risk. The results of the analysis should be presented carefully to other executives . It should be explained that a hedge does not ensure that profits will be higher. It means that profit will be more certain. When futures/forwards are used both the downside and upside are eliminated. With options a premium is paid to eliminate only the downside.
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This note was uploaded on 01/26/2010 for the course FINA 2802 taught by Professor Xia during the Fall '09 term at HKU.

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