Hedge Forex Risk with Futures Contracts: A Practical Example

Part I: To hedge the entire import transaction, we need to determine the number of forex futures contracts required.

The amount in Euros needed for the transaction is 500,000 Euros. The hedge ratio is given as 0.75.

The number of contracts required can be calculated using the formula:

Number of contracts = (Amount in Euros / Contract value) / Hedge ratio

Contract value = €125,000 Hedge ratio = 0.75

Number of contracts = (500,000 Euros / €125,000) / 0.75 Number of contracts = 4 / 0.75 Number of contracts = 5.33

Since the number of contracts must be a whole number, we will round up to the nearest whole number.

Number of forex futures contracts required = 6

Part II: Given: Futures price after 6 months = 1 EUR = 1.1235 USD Spot exchange rate after 6 months = 1 EUR = 1.1225 USD

To compute the effective price of each Euro in USD, we need to compare the futures price and the spot exchange rate.

If the futures price is higher than the spot exchange rate, it means the Euro has appreciated against the USD.

Effective price of each Euro = Spot exchange rate after 6 months

Effective price of each Euro = 1.1225 USD