International Finance

Suppose you are the CFO of a European company. Your company is going to receive a US dollar payment of 1 million in one year time. You want to fix the future exchange rate between the euro and the dollar at a relatively less risky rate by entering into a one-year forward contract.

Required:

(i) Estimate the historical volatility of USD/EUR exchange rates using 15 years of daily data.

(ii) Assume that your company can not afford a risk of more than 25% of the volatility you estimated in part (i). Explain how exactly you would hedge your company's exchange rate risk. It involves finding forward quotes and calculating the amount you will pay or receive one year later.

(ii) Instead of the forward contract, if you wanted to use futures contracts, in what ways would this be different from hedging with forwards.