A US company will be selling a large machine to a company in Mexico exactly one year from now in exchange for a payment of 60,000,000 Mexican Pesos. You are an analyst who is considering different ways of hedging this risk exposure.

(a ) Find the 5% and the 1% VAR if the company does not hedge and the annual standard deviation is 10000 pips (1.0000) and the mean is assumed to be one year forward price calculated from Barchart.

(b) Forward Market Hedge:

(i) Find the appropriate forward rate for a 12 month forward from Barchart.com. Calculate the position you should take in the forward market to hedge the cash flow.

(ii ) Draw a diagram showing the value of the large payment expressed in US dollars if the spot exchange rate changes by the following amounts over the next year: -20%, -15%, -10%, -5%, 0, 5%, 10%, 15%, 20%. Show separately the unhedged position, the forward contract and the net position.

(c) Futures Market Hedge:

Describe three differences if you used a futures contract to hedge in (a) instead of a forward contract

(d) Money Market Hedge:

Describe the steps you would take to hedge by borrowing money in one market, converting it to other currency and investing it. (Assume you can borrow and lend in the US at 3% and in Mexico at 7%).

(e) Hedge with Options:

Use the quote from the CME group at the options tab on the futures page to select a strike price and obtain a price for an appropriate option. Draw a diagram that shows the (i) unhedged position, (ii) the value of the hedge, and (iii) the net position in US dollars that will be received if the exchange rate changes by -20%, -15%, -10%, -5%, 0, 5%, 10%, 15%, 20%

For Question 1, the one year forward rate adjustment in Barchart for USD/MXN is not in pips - it is in full units (10,000 pips). In other words, a quote of 1.025 is actually 10,250 pips. This is done because the interest rate difference is large (MXN = 7.5% for one year and USD = 1.5% for one year). This means the forward price is about one full peso above the spot price.

The other tip for question 1 is that you should calculate the VAR using the pips (about 10,250 for the mean; 10,000 for the standard deviation). Once you have the calculation from the normal distribution of the 1% (or 5%) tail, apply this to the expected forward price to see the 1% (or 5%) worst case result for the actual forward price. You can then find the loss if you are unhedged on the 60,000,000 pesos when they are converted to USD.

and i think the forward rate for a year i find from the barchart.com may to he use :1.0200