HedgingExchangerateexample

AssumeahedgerlocksinonapriceinOctoberwithaEuropeanbuyerthatimplies50MEuroforasale
inDecember.ThecurrentspotEUR/USDexchangerateis1.4704(thisimpliesthat1Europurchases
$1.4704inUSD).
1. WhatistheimpliedsaleworthinUSDgiventhecurrentexchangerate?

=50,000,000*1.4704=73,520,000=$73.52M

2. WhatisthevalueofthesaleiftheEUR/USDexchangerate:
a. Declinesto1.3200

=50M*1.320=$66M(lossof$7.52M)

b. Increasesto1.620

=50M*1.620=$81M(gainof$7.48M)

3. Considerashorthedgeinthefuturesmarket,wherethehedgergoesshorton400December
futurescontractsat1.4605.Giventhateachcontractisworth125,000Euro,thetotalvalueof
400contractsis50MEuro.Whatarethegains/lossesiftheEUR/USDexchangerate:
a. Declinesto1.3200

Futurescontractisworthanincreasedvalueequalto$7.025M(=(1.46051.3200)*50M).
Thegaininvalueisbecausethecontractissoldfor1.4605andboughtfor1.3200.This
increasedvalueleadstoanetlossof495,000(=$7.025M$7.52)duetobasis.

b. Increasesto1.620

Futurescontractisworthadecreasedvalueequalto$7.975M(=(1.6201.4605)*50M).
Thelossinvalueisbecausethecontractisboughtfor1.4605andsoldfor1.620.This
decreasedvalueleadstoanetlossof495,000(=$7.48M$7.975)duetobasis.

4. Considertheuseofputstoguardagainstdownwardexchangeratepressure.Assumethe
companypurchases400atthemoneyDecemberputswithastrikepriceof1.46(withfuturesat
1.4605)for0.0326.
a. Whatistheinitialcost

=(400*125,000)*.0326=1,630,000

b. Whatisthegain/lossiftheratedecreasesto1.32

Theputpaysout$7M(=(1.461.32)*(400*125,000)),whichaftertheinitialcostleadsto
anetgainof$5.37Minthevalueofthecontract.Thispartiallyoffsetsthelossinasset
valueof$7.52M,leadingtoanetprofitof$2.15M(=$5.32M$7.52M).

c. Whatisthegain/lossiftherateincreasesto1.64

Theputisnotexercisesincethepriceisabovethestrike.Thereforeaftertheinitial
cost,thenetprofitis$5.85M(=$7.48$1.63M).

Unhedged
Shortfutureshedge
Longputhedge

Decreasesto1.32
$7.520M
$0.495M
$2.150M

Nochange
$0.020M
$0.495M
$1.650M

Increasesto1.62
+$7.480M
$0.495M
+$5.850M