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1. For the future contract will it be correct if the calculation for under-hedge be ok?
For the question the Number of contracts = MR96,461,668/MR500,000 = 192·9, say 193
For general approach do we always over hedge when is decimal point is more than 0.5?
2. For the calculation on the forward contract.
Exchange rates (quoted as US dollar per Malaysian Ringgit US$/MR1)
Spot 0·2355 – 0·2358
Four months forward 0·2370 – 0·2374
why use 0.2374 and not 0.2370?
Thanks in advance for your reply.
1. Do not simply learn a rule (because it depends on whether they are receiving or paying the other currency) but think through the logic.
The are hedging a net receipt of $22.9M which would need 192.9 contracts. By using 193 contracts they are hedging a receipt bigger than $22.9M and therefore they are hedging more than they will actually be receiving – so they have over hedged.
2. Because the futures will convert more $’s than they actually are going to receive, then will need to buy the extra $’s and the forward rate for buying $’s is 0.2370 (and the answer has used 0.2370 for this part).
(The 0.2374 that has been used for the futures themselves is the lock-in rate. It is only by coincidence that this happens to be the same as one of the forward rates.)