Forward and Futures Hedging, Spread, and Target Strategies

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CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD, AND TARGET STRATEGIES END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. (Short hedge and long hedge) Another type of hedge situation is faced when a party plans to purchase an asset at a later date, such as a bread maker. Fearing an increase in wheat prices, the bread maker would buy futures contracts. Then, if the price of wheat increases, the wheat futures price also will increase and produce a profit on the futures position. That profit will at least partially offset the higher cost of purchasing wheat. This is a long hedge, because the hedger, the bread maker here, is long in the futures market. Because it involves an anticipated transaction, it is sometimes called an anticipatory hedge.…show more content…
January 2 The bank sells 50 contracts. February 28 The 5,000,000 Canadian dollars are converted at a rate of $0.7207 for 5,000,000($0.7207) = $3,603,500 a decrease in value of $178,500. The futures contracts are bought for $0.7220 or 100,000($0.7220) = $72,200 This produces a profit on the futures of 50($75,410 – $72,200) = $160,500 This reduces the loss on the currency conversion to only $18,000. The hedge eliminated 90 percent of the loss. 9. (Intermediate- and Long-Term Interest Rate Hedges) a. The spot bonds are worth 0.78875($5,000,000) = $3,943,750 The futures price is 71.25. The number of futures contracts is Nf = (7.81/8.32)($3,943,750/$71,250) = 51.9 So buy 52 contracts at a price of $71,250 each. b. The spot bonds are worth 0.8275($5,000,000) = $4,137,500 This is an increase of $193,750. The futures price is 76.4375. The profit from the futures transaction is 52($76,437.50 – $71,250) = $269,750 The net profit on the hedge is $269,750 – $193,750 = $76,000 10. (Intermediate- and Long-Term Interest Rate Hedges) a. The manger is long the bonds and is exposed to a fall in the price of the bonds, so the appropriate transaction is to sell 13 contracts. b. The spot bonds are worth 1.01375($1,000,000) = $1,013,750 The profit is $1,013,750 – $1,074,375 = –$60,625 The futures price is
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