Hedging with
Futures Contracts
Tyler Gaspard
Futures Contracts
 Futures contracts specify delivery of fixed
quantities of foreign currencies on a set date
in the future
 Traded on an organized exchange.
 Standardized by size and delivery date to
make trading easier
Futures vs Forwards
 FUTURES
 Traded on organized
exchange
 Market determines price
 ~ $100,000
 Standardized maturity
 Require initial deposit
into margin account
 Daily settlement of G/L
 FORWARDS
 Traded on inter-bank
market
 Prices set by contract
 > $1 million
 Customer-tailored maturity
 Rarely require cash
payment before maturity
 Settled on maturity
Futures Contracts
 Advantages
 Liquidity: can be
traded before maturity
at little cost
 Size: more useful for
hedging small
exposures
 Limitations
 Only available in a
few currencies, thus
requiring crosshedging
 Must be purchased in
whole contracts, thus
perfect hedging is not
always possible
Most Useful Hedges
 Unknown transaction dates
 Can liquidate futures position anytime before
maturity or roll over to a later maturity
 Unknown transaction amounts
 Easy to change futures position
 Small transactions
Hedging with Futures
 Important dates to keep in mind:


t---------------- t + n -------------------T
inception
liquidation
maturity
 Gain/Loss Equation = X[(St+n – bSt) – (Zt+n - Zt)]
 b = [1 + it,t+n]months/12 / [1 + i*t,t+n]months/12
Futures Held to Maturity
 Enables a perfect hedge just like a forward
contract
 Futures and forwards are priced according to
covered interest parity
 Futures at maturity = Spot Rate
 Futures at inception = Forward with same maturity
 Losses from exchange rate changes will be
perfectly offset by gains in the futures contract
Futures Not Held to Maturity
 Will not provide for perfect hedges for
two reasons
 Futures price at liquidation date has not yet
converged to the spot exchange rate.
 Interest rates at liquidation date are not
known in advance and are likely to change
between inception and liquidity.
Example

Atkinson Enterprises, a US consulting firm, has
provided services to its neighbors to the north,
Cannuck Manufacturing, a Canadian firm. These
two firms have done business together for years,
so Atkinson has allowed Cannuck up to six months
to pay its bill of 100,000 $Canadian. The current
spot rate is $.70 US/ 1 C$. Interest rates are 5%
on Canadian deposits and 8% on US deposits.
Three months later, Cannuck pays its bill. The US
dollar has appreciated over this time to a spot rate
of $.68/1 C$.
Scenario 1
 Atkinson chooses to not hedge
 Loss from exchange risk =
 100,000 [(.68 – b(.70)]
  b = [1.083/12]/[1.053/12] = 1.0071
 Loss from exchange risk = -$2,494.73
Scenario 2
 Atkinson hedges the original transaction
by selling one Canadian Futures contract
with a six month maturity date. The
contract is sold at a price of .7150. When
Cannuck payment is received three
months later, Atkinson buys one
Canadian futures contract to close its
position. The futures price at this time
has dropped to .7000.
Scenario 2
 Loss from exchange risk = -2,494.73
 Gain from futures contract =
 100,000(.7150 - .7000) = 1500
 Net Loss = -2,494.73 + 1500 = -994.73
 Hedging has saved Atkinson
Enterprises $1500.