Namanje Inc is a company located in Zambia that has a contract to purchase goods from Botswana

in two months' time on $1$ September. Zambia uses the indirect method of quoting exchange rates.

The payment is to be made in Pula and will total $140$ million Pula.

The managing director of Namanje Inc wishes to protect the contract against adverse movements

in foreign exchange rates and is considering the use of currency futures. The following data are

available.

Spot foreign exchange rate

$S(ZM\frac{W}{B}WP)=128\mathrm{.}1500$

Pula currency futures contracts on ZEDMEX $($Zambia Monetary Exchange$)$

Contract size $12,500,000$ Pula, contract prices are Zambian Kwacha per Pula.

Contract prices:

September $,0\mathrm{.}007985$

December $,0\mathrm{.}008250$

Assume that futures contracts mature at the end of the month.

Required:

a$)$ Illustrate how Namanje Inc might hedge its foreign exchange risk using currency futures.

$(3$ marks$)$

b$)$ Explain the meaning of basis risk and show what basis risk is involved in the proposed

hedge.

$(4$ marks$)$

c$)$ Assuming the spot exchange rate is $120$ BWP$/$ZMW on $1$ September and that basis risk

decreases steadily in a linear manner, calculate what the result of the hedge is expected to