How would the firm hedge using futures contracts

Reference no: EM132206441

Question - Suppose a U.S. firm is due to pay a European firm 1,000,000 in December 2018. The firm wants to hedge its transaction is exposure, and is contemplating three methods of doing so. To answer these questions, you will need to go look up prices of futures and options contracts on the CME Group website. The value of 1 Euro futures or options contract on the CME is 125,000, meaning that the firm will hedge using 8 contracts. The firm will be trading contracts that expire in December 2018, since that is when its payment is due.

1. How would the firm hedge using futures contracts? Would the firm take a long or short position? What is price of the December 2018 futures contract? What is the final payoff for the firm if the Euro ends up 2% lower than the December 2018 futures price? What is the final payoff for the firm if the Euro ends up 2% higher than the December 2018 futures price?

2. How would the firm hedge using at the money option contracts? An at the money option is one with the strike price closest to the December 2018 futures price. Would the firm buy call or put options? What is the price of the option? What is the final payoff for the firm if the Euro ends up 2% lower than the December 2018 futures price? What is the final payoff for the firm if the Euro ends up 2% higher than the December 2018 futures price?

3. Repeat part 2 assuming the firm uses out of the money option contracts. Choose the option with a strike price approximately 1% away from the December 2018 futures price.

Reference no: EM132206441

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