Brazilian real hedging with futures The US dollar (USD) to Brazilian real (BRL)
ID: 2612611 • Letter: B
Question
Brazilian real hedging with futures
The US dollar (USD) to Brazilian real (BRL) exchange rate was 0.5793 USD/ BRL on October 21, 2010. By January 17, 2011 it had moved to 0.5934 USD/ BRL. Over the same time-period, BRL 3-month futures had moved from 0.5826 USD/ BRL. Assume the maturity date of this BRL futures contract to be December 21, 2010.
1. If your organization imported goods worth 0.5 million BRL, how many BRL futures contracts will be needed for hedging against currency risk? {Assume each BRL futures contract has a face-value of 100,000 BRL}
2. Describe the futures hedging strategy. What is the outcome of the 3-month hedging strategy that you have implemented?
Explanation / Answer
Answer to part-1 of the question:
Value of goods imported = BRL 500,000
Value of imported goods in USD = 500,000* 0.5793 = USD 289,650
Exchange rate in futures contract = 0.5826 USD/BRL
In other words, 1 USD = 1.7164 BRL (based on the rates of Futures Contract)
Therefore, amount in USD to be paid to pay for the goods (if Futures Hedging is done) = USD 289,650*1.7164 = BRL 497,168
Face value of 1 Futures Contract = BRL 100,000
Hence, the company would about 5 futures contracts to cover the entire payment of BRL 497,168
Answer to part 2 of the question
In this future hedging strategy, we know that the exchange rate is going upwards from 0.5793 USD/BRL in October 2010 to 0.5934 USD/BRL. Hence, if the company wants to ensure that it its margins are not hit by the increasing exchange rates, it enters into a futures hedging transaction wherein the company agrees to buy the currency at a subsequent date not at the market rate but at a fixed rate as per the future contract, that is 0.5826 USD/ BRL.
The outcome is that the company could save a significant amount in this transaction as given below:
Amount paid to close the transaction using hedging = BRL 500,000* 0.5826 = USD 291,300
On the other hand, the company would have paid the amount using the exchange rate = 0.5934 USD / BRL
= BRL 500,000*0.5934 = USD 296,700
hence a saving of = USD 296,700 - USD 291,300 = USD 5,400