Chapter Ten
Foreign Exchange Futures
Multiple Choice
1. Suppose a U.S. investor buys shares on a foreign stock exchange. When the shares are
eventually sold, the holding period return will be
a. greater if the dollar appreciated relative to the foreign currency.
b. lower if the dollar appreciated relative to the foreign currency.
c. independent of foreign exchange movements.
d. equal to the implied interest rate in the foreign currency futures contract.
ANSWER: B
2. A U.S. manufacturer who sells goods abroad is most likely to hedge foreign exchange risk by
a. buying U.S. dollar futures.
b. selling U.S. dollar futures.
c. buying foreign currency futures.
d. selling foreign currency futures.
ANSWER: D
3. A U.S. manufacturer who buys goods from abroad is most likely to hedge foreign exchange
risk by
a. buying U.S. dollar futures.
b. selling U.S. dollar futures.
c. buying foreign currency futures.
d. selling foreign currency futures.
ANSWER: C
4. Suppose German interest rates rise by 1%, while U.S. rates do not change. The price of a
Deutschmark futures contract will most likely _______.
a. rise
b. fall
c. be unaffected
d. become less volatile
ANSWER: B
5. With foreign exchange futures, which of the following is most analogous to "the storage
costs" associated with agricultural futures?
a. interest rates
b. commission rates
c. forward market rates
d. the good faith deposit
ANSWER: A
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6. Foreign exchange futures pricing is explained by all of the following except
a. purchasing power parity
b. put/call parity
c. interest rate parity
d. cost of carry model
ANSWER: B
True/False
1. Foreign currency futures contracts, regardless of the associated currency, are all based on
100,000 units of the foreign currency.
ANSWER: F
2. A Yen futures contract priced in U.S. dollars is exactly the same as a U.S. dollar futures
contract priced in Yen.
ANSWER: F
3. Foreign exchange futures are sensitive to changes in interest rates.
ANSWER: T
4. The price of a foreign exchange futures contract is partially a function of the term of the
futures contract.
ANSWER: T
5. Someone with a long hedge in foreign exchange futures could very logically take delivery of
the foreign currency.
ANSWER: T
6. Someone with a short hedge in foreign exchange futures could very logically take delivery of
the foreign currency.
ANSWER: F
7. Foreign exchange futures prices are a function of the cash price and the carrying costs
associated with the futures contract.
ANSWER: T
8. Beta is a necessary component of most foreign currency hedges.
ANSWER: F
Short Answer/Problem
1. You are a buyer for a major department store chain, and have just entered into a contract with
a German supplier to purchase various types of cooking utensils and silverware. The
contract you signed calls for you to pay DM 10 million on the 1st of October by wire transfer
between banks. To reduce the risk of foreign exchange losses, you decide to hedge using the
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September futures contract, which settled yesterday at $0.5527. There are DM 125,000 in
one futures contract.
a. How many futures contracts would you buy or sell to do this?
b. Suppose that two weeks after you place your hedge the price of the futures contract has
risen to $0.5812. What would be the advantages and disadvantages of closing out the
futures contract positions at that time?
c. Based on your answer to part a, and assuming that the good faith deposit required for
each contract is $1500, how much money would the clearinghouse show in your good
faith deposit account when the futures price was $0.5812?
ANSWER:
a. There are DM 125,000 per contract, so you need DM 10 million/DM 125,000 = 80
contracts. Because you need the German currency, you would buy 80 contracts.
b. If you closed out the futures positions, you would have a gain on the contracts, but
you would remove the foreign exchange hedge and would be exposed to the risk of
fluctuating currency values.
c. The initial good faith deposit is 80 x $1,500 = $120,000. Marking to market effects
are 80 x (.5812  .5527) x DM 125,000 = $285,000. The total in the account would
be $405,000.
2. Suppose you are a U.S. manufacturing firm that routinely buys raw materials from foreign
countries. List reasons in favor of and against a policy of continual hedging of foreign
exchange risk using foreign exchange futures.
ANSWER: The principal advantage of continual hedging is the removal of the foreign
exchange risk. The principal disadvantage is the cost of monitoring the hedges and the
necessity to post the various good faith deposits.
3. Suppose you manage a U.S. manufacturing firm that routinely buys and sells goods to or
from firms in foreign countries. List reasons in favor of and against a policy of continual
hedging of foreign exchange risk using foreign exchange futures.
ANSWER: If you buy and sell abroad to a variety of countries, you can argue that the effects
of foreign exchange risk will “net out” such that the risk is diversified away. This may be
true in some circumstances, but should not be relied upon as a general rule.
4. Suppose a local in the DM futures pit hears a news item indicating Japanese inflation is
likely to be greater than previously anticipated. Is this news more likely to increase or to
decrease the price of Yen futures contracts?
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ANSWER: Increasing inflation tends to increase the interest rates in the affected country.
An increase in interest rates will depress the value of a foreign currency futures contract.
5. Is it logical to expect that hedging via foreign exchange futures will "increase your rate of
return" over the long term?
ANSWER: No. Futures contracts are designed to reduce risk rather than to augment return.
It may be the case that by reducing risk that is potentially unnecessary the long-term rate of
return could be higher, but hedgers should focus on the risk reduction aspect of the futures
system.
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