On January 10, VW agrees to import auto parts worth $7 million from the US. The
ID: 2777858 • Letter: O
Question
On January 10, VW agrees to import auto parts worth $7 million from the US. The parts will be delivered on March 4 and are payable immediately in dollars. VW decides to hedge its dollar exposure by entering into CME futures contracts. On Chicago Board each euro futures comes with a notional of €125,000 per contract. Only integral number of contracts can be bought or sold. The spot exchange rate on January 10 is €1.1177/$, and the March futures price is €1.1109/$. On March 4, futures close at €1.1151/$, while the realized spot rate is €1.1171/$.
What will be VW’s total cost of payables in Euros under the following three scenarios?
1. Remain unhedged. (2 Points)
2. Hedging through CME Euro- futures. Specify number of euro futures
contracts. Also specify whether long or short? (4 Points)
3. If the hedged position is closed on March 4 and dollars are bought in spot market.
Explanation / Answer
Total Liability payable on 4th March = $ 7,000,000
On January 10th
Spot Exchange rate = € 1.1177 / $
March Futures Price = € 1.1109/$
On March 4th
Closing price of March Futures = € 1.1151/$
Spot exchange rate = € 1.1171/$
Answer (1)
If VW’s payable is unhedged,
Total cost of Payables = Amount payable in $ * Spot exchange rate on 4th March
= $ 7,000,000 * € 1.1171/$ = € 7,819,700
Answer (2)
VW has a payable in Euro in March. That is they need to buy Euro to make the payment. Hence the company needs to go long on March futures.
March Futures Price = € 1.1109/$
Total Euro amount based of futures price = $ 7,000,000 * € 1.1109/$ = € 7,776,300
Value of each CME futures contract = € 125,000
Total Number of contracts to be purchased = € 7,776,300 /€ 125,000 = 62.21
Total number of Euro-futures contracts to be purchased by VW = 62
Answer (3)
VW purchased 62 Euro futures contracts at € 1.1109/$ on January 10 and close the same on March 4th at € 1.1151/$
Total value of Euro futures contracts purchased = 62 * € 125,000 = € 7,750,000
March Futures Price = € 1.1109/$
March Futures closing price = € 1.1151/$
Profit on sale = 1.1151 - 1.1109 = 0.0042
Profit on sale of 62 Euro-futures contracts = € 7,750,000* 0.0042 = € 32550
Purchase of Euro in spot market on March 4th = $ 7,000,000 * 1.1171 = € 7,819,700
Less : Profit on closure of futures contracts = € 32,550
Total amount payable = € 7,787,150