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Dear John,
Extracted from Mar/Jun 2016 answers, Question 1 b ii (Appendix 2):
Number of contracts bought = $23,121,387/$125,000 = approximately 185 contracts (resulting in a very small over-hedge and therefore not material)
[Full credit will be given where the calculations are used to show the correction of the over-hedge using forwards]
Can you please help me to understand what I am missing from the statements above regarding the over-hedge? What is the over-hedge and how do we show the calculation to correct?
Thank you.
Okay, I realise the small over-hedge is (125,000 x 185) – 23,121,387 = $3,613. But how do I show the calculation to correct?
Thanks,
185 contracts would have exactly hedged a € receipt of 185 x 125,000 x 0.8650 = €20,003,125.
Given that they actually receive only €20M, they have hedged too much and would therefore have to buy €3,125 to complete the deal if they were to avoid risk completely. So they would use the forward rate and convert at $1.1601.
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