Since EUR/USD exchange rate fluctuates every day, the US dollar value of your 2.
ID: 2750023 • Letter: S
Question
Since EUR/USD exchange rate fluctuates every day, the US dollar value of your 2.5 mil Euros in the future uncertain, which is called exchange rate risk. Your objective is to lower this exchange rate risk. You decide to hedge against this risk using EUR/USD (=Euro FX) futures contract expiring in December 2015.
1. What’s the difference between Euro FX futures and Eurodollar futures?
2. You are converting the currency in late November. But why do we need to use December 2015 futures instead of November 2015 futures? And what is the contract size of the Euro FX futures contract?
3. How many Euro FX futures contract do you have to buy or short to hedge the risk? Specify explicitly whether you are taking a long or short position of the Euro FX futures.
Explanation / Answer
1.
Euro dollars futures are very different from Euro FX futures. Eurodollars have nothing to do with Europe's single currency that was launched in 1999. Rather, eurodollars are time deposits denominated in U.S. dollars and held at banks outside the United States. A time deposit is simply an interest-yielding bank deposit with a specified date of maturity
The name eurodollars was derived from the fact that initially dollar-denominated deposits were largely held in European banks. At first these deposits were known as eurobank dollars. However, U.S. dollar-denominated deposits are now held in financial centers across the globe and referred to as eurodollars
Euro FX are actual futures contracts which are used for hrdging purposes. These are used for buying USD and selling Euro and vice versa purposes.
2. Euro FX futures are typically matures only at the end of the quarter of the year. So there are only 4 maturities contractors available in the market namely March, June, September and December
So in late November, you should either go for December 2015 or March 2016 future contracts.
Contract size of Euro FX futures is 125,000 euro
3. To hedge 2.5 million Euro, one should buy 2500000 / 125000 = 20
One should hedge using 20 contracts
Since you have to convert your 2,5 million euro in future, you should long the EURO FX futures contract.
Here you have the right to execute contract but not the obligation