Chapter Ten Foreign Exchange Futures Answers to Problems and Questions

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Chapter Ten
Foreign Exchange Futures
Answers to Problems and Questions
1. There is no single correct answer to this. Some research suggests that
hedging foreign exchange risk in investment portfolios is not a good idea
because it reduces the risk/return ratio of the portfolio. On the other hand,
when a specific, unacceptable risk arises, you should seriously consider
removing it.
2. It would give you greater flexibility, but it would also be more risky. By
replacing the forward contract twice, you would not know in advance the
precise price at which the currency transaction would occur.
3. a) A rise in inflation generally results in an increase in interest rates. b)
Because the increase in inflation was the same in both countries, the
relative exchange rates probably will not change.
4. Economic exposure measures the risk that the value of an investment will
fall because of adverse foreign exchange movements. Accounting exposure
deals with the consolidation of financial statements.
5. The forward market is not intended to be an opportunity for speculation or
investment. People should not expect “gains or losses” from using them.
6. A U.S. business might sell something to a German firm, and the German
company might be invoiced in Deutschmarks. The value of the DM could
change before the bill is collected, so the U.S. firm might hedge this risk by
promising to deliver the DM at a set exchange rate when they are received.
7. Table 10-6 shows the basic foreign currency futures pricing relationship. If
the local currency rate rises, the futures price will decline. This is not what
a person with a long position in euro futures wants.
8. If you hedge a greater quantity of an asset than your economic interest, the
“extra” hedge amounts to a speculation. A parallel example from the
option market is the case of someone who owns 500 shares of XYZ stock
and purchases 7 at-the-money “protective” puts. Delta considerations
aside, you could argue that the extra 2 contracts are speculative.
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Chapter Ten. Foreign Exchange Futures
9. $1.00 = G1.4456  $0.6918 per unit of G
.6918  .7100 12
x x100  15.38%
.7100
2
The country G interest rate should therefore be 8.68% + 15.38% = 24.06%
10. Individual response
11. Individual response
12. C$1.00 = $0.75
If U.S. inflation increases by 1%, the U.S. dollar will depreciate by 1%.
$0.75 = C$1.00
$1.00 = C$1.3333
Changing by 1%,
$1.01 = C$1.3333
$1.00 = $1.320
13. Individual response
14. Individual response
15. There are CHF125,000 per contract. To hedge CHF58 million, sell
CHF58 million
 464 contracts
CHF125,000
contract
16. Bonds accumulate interest, so the hedge might choose to increase the
number of contracts to account for the final interest check in addition to the
principal.
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Chapter Ten. Foreign Exchange Futures
17. Calculate the new hedge ratio:
CHF60 million
 480 contracts
CHF125,000
contract
This means the hedger needs to sell 16 more contracts.
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