Question:

Qn 1. If the firm uses the futures contract hedge, explain the hedging action that it should undertake. Also compute the number of futures contracts required for the hedge.

Qn 2. Using the futures hedge, calculate the net GBP inflow in 3 months if the finance officers forecasts came true.

Qn3. Compute the gain/loss in GBP in the spot market and comment on the result.

Qn 4. Briefly discuss two disadvantages of the UK firm hedging using a futures contract, which are not applicable in using options contract hedging.

Given the below:

A UK firm exports equipment to Hong Kong. It has contracted to receive HKD10 million in 3 months from its client. Today, the rates are as follows:

Spot rate: Great British Pounds (GBP) 1 = Bid HKD 9.50 and Offer HKD 9.54

HKD/GBP futures price = GBP 0.09500 per HKD

The UK firm is concerned about movements in the GBP/HKD exchange rate. Its recently employed finance officer forecasts these data in 3 months:

Spot rate: GBP1 = Bid HKD 8.95 and Offer HKD 9.20

GBP/HKD futures = HKD 10.0000 per GBP

The specifications for the HKD/GBP futures contract are as follows:

Contract Size : HKD125,000

Minimum fluctuation: 1 tick (0.0001) equals GBP12.50 per contract.