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good Morning Sir!
a uk co has to pay a us supplier $2.4m.in 3 month’s time.
one strike price given is 1.62 $/gbp
in calculation the # of contacts
we do: 2400000/1.62/62500 = 23.7
the answer also comes with 23.7 but it is rounding the contracts down to 23 rather than 24.
any special reason as to why?
also, at 23 contracts, the full amount of payment is not hedged and it hedges the difference using the forward rate – which i understand
BUT
i wd like to know what if any treatment is to be done if the amount hedged is greater than the payment??
regards
It does not matter which way you round the number of contracts – you will still get full marks.
If there is an over or under hedge then you could use the forward rate to either sell the excess currency or else to buy the excess currency.
If 24 was the number of contract how would the calculation for hedging would have changed ?
Thank you. 🙂You should not need me to repeat the whole of the arithmetic. It would be the same approach as before with the difference that there would be an over-hedge instead of an under-hedge. Again the forward rate would be used but 1.6037 instead of 1.5996 because they would be selling USD rather than buying them.
Have you watched my free lectures on the management of foreign exchange risk?
Yes I have watched it but things are quite confusing at last moment
So it would be
Unhedged amount = (1,500,000X1.62) -2,400,0000 = 30000
Hedged using forward market – 30000/1.6037 = 18707
Premium – 24×62500×0.0342 =51300/1.5938 =32187Total payment would be – 1500000 -18707+32187 = 1513480
Is it correct ?
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