Question
Hedging Exchange Rate Risk with Futures: Suppose a US financial institution has $100 million is US borrowings and $100 million worth of borrowings in EUR.
Hedging Exchange Rate Risk with Futures: Suppose a US financial institution has
$100 million is US borrowings and $100 million worth of borrowings in EUR. Additionally,
it has given out $125 million loans in EUR to European firms. The remaining $75 million
are given out as loans to US institutions. The current spot rate is 0.87 EUR per USD
while the 1-year futures are available at 0.90 EUR per USD.
(a) What is the financial instutions net exposure?
(b) Is the FI exposed to dollar appreciation or depreciation relative to the EUR?
(c) Suppose the financial institution is not involved in any hedging. What would be the
gain/loss on the balance sheet if, the next year, USD appreciates to 0.90 EUR per
USD in the spot market. Assume the interest rates on assets as well as liabilities
are 0% for all currencies.
(d) What is the number of futures contracts necessary to fully hedge the currency risk
exposure of the FI? The contract size is EUR 25,000 per contract. Assume that
a regression of past changes in the spot exchange rate on changes in the future
exchange rate generates an estimated slope of 1.6.
(e) If the EUR futures exchange rate changes from $0.90 EUR per USD to $0.92 EUR
per USD, what will be the impact on the FIs futures position?
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