Foreign Currency Obligation and Hedging Exchange Rate Risk


In mid-September your firm had a foreign currency obligation to pay £5 million in mid-September 2016. You were asked to assist in hedging the exchange rate risk.  At the time you gathered the following information:

  1. Spot exchange rate in mid-September (S0): $1.5705/₤.
  2. 360-day forward (F360) quotes for the pound in September: $1.5095 - 04/₤.
  3. Eurocurrency rates from a large bank:

Term                                                    U.S. dollar                                           pound sterling

12-month borrowing rate                    2.000% p.a.                                         6.050% p.a.

12-month deposit rate                         1.850% p.a.                                         5.948% p.a.                

  1. The Sep 2016 futures price at market opening at the time in mid-September 2015 was $1.5099/₤. Each contract is for ₤62,500.
  2. Relevant option market information in September 2015 was:

                                                Strike              Call                 Put                  Expiration

                                                15300              6.57                 2.50                 September 2016

  1. Assume that in mid-September 2016 when the payment is received the spot exchange rate is $1.6200/₤.


  1. i. If you hedged in the forward market:
  2. a. What currency did you buy or sell in the forward market?
  3. b. What would be your net dollar cost in September 2016 using the forward hedge?
  4. c. Compared to the do-nothing option, what would be the exchange rate gain/loss in September 2016 from hedging with the forward?


  1. ii. If you hedged in the futures market:
  2. a. Did you buy or sell futures contracts?
  3. b. What would be the profit/loss on the futures market transaction in September 2016?
  4. c. What would be your net dollar cost in September 2016 considering the futures hedge?
  5. iii. If you hedged using options:
  6. a. Did you buy/sell calls or puts?
  7. b. What would be your net dollar cost in September 2016 considering the options hedge?
  8. c. Relative to the do-nothing option, what would be your exchange rate gain or loss in September 2016 from using options?
  9. iv. If you hedged using a money market hedge:
  10. a. What would be your dollar cost in September 2016 using the money market hedge?
  11. b. What exchange rate would you lock in?


This question belongs to international finance and discusses about foreign currency obligation.

Word count: Excel format


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