Demonstrate that the hedge is perfect by illustrating payoff

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Suppose a German company will receive US$2,000,000 in three months and they wish to hedge the foreign exchange rate risk associated with this payment. The spot exchange rate is $1 = Euro 0.70.

They estimate that if the US dollar falls by Euro 0.10 (i.e. to $1 = Euro 0.60) then the company will lose Euro 200,000 on the transaction.

If the current three month futures price is $1 = Euro 0.78 and dollar futures contracts are for $100,000 each, how should the company hedge its position?

Demonstrate that the hedge is perfect by illustrating net payoff for a Euro 0.10 fluctuation in exchange rates from current spot prices.

Reference no: EM132008591

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