FIN 5535 Project: Currency Hedge,

Due date: 8/10/2015 (end of week 7) 

The sample period for this project is from 6/30/2015 to 7/31/2015.

At the start of the sample period, your company receives 2,500,000 Euros, which you plan to convert into US dollars at the end of sample period for tax reasons. 

Since EUR/USD exchange rate changes every day, the US dollar value of your Euros at the end of the sample period will be uncertain. Your objective is to lower this exchange rate risk. You decide to hedge this risk using EUR/USD (=Euro FX) futures contract expiring in September 2015.

10 Questions (each is worth 1 point):

1. What’s the difference between Euro FX futures and Eurodollar futures?

2. You are converting the currency in late July/early August. But why do we use September 2015 futures instead of July 2015 or August 2015 futures? And what is the contract size of the Euro FX futures contract?

3. How many Euro FX futures contract do you have to buy or short to hedge the risk? Specify explicitly whether you are taking a long or short position of the Euro FX futures.

4. For every trading day (no weekends/holidays) during the sample period, collect the daily EUR/USD exchange rate and EUR/USD futures price. See hint #2 for how to collect historical futures prices. Construct a spreadsheet showing both prices.

5. Assume the initial margin requirement is $4,000 per contract. Calculate the initial margin account balance.

6. Calculate the futures daily gains, cumulative gains every day.

7. Calculate the margin account balances every day. Is there a margin call, when the maintenance margin requirement is $3,300 per contract? If yes, add the required cash to the margin account to restore initial margin account requirement.

8. Calculate the values of your unhedged position (= 2.5 mil Euros in US $), and the values of your hedged position (= unhedged value + futures cumulative gain).

9. Plot the unhedged values and hedged values in Q7 over time. In addition, calculate the standard deviations of the unhedged values and that of the hedged values in Q7. Discuss the results.

10. Using Q9 answers, confirm that you successfully lowered the exchange rate risk.

Hints:

1. Your spreadsheet must include at least the following columns for each trading date: 1) Date, 2) EUR/USD exchange rate, 3) EUR/USD futures price, 4) Futures daily gain, 5) Cumulative gain, 6) Margin account balance, 7) Unhedged value and 8) Hedged value (= unhedged value + cumulative gain).

2. Usehttp://www.cmegroup.com/ (where EUR/USD futures contracts are traded) to locate the EUR/USD futures and collect the futures prices. The screenshot below shows that the EUR/USD futures price on 12/22/2014 was 1.2239.

Video tutorial: https://www.youtube.com/watch?v=qBPkVOjOvDA

3. To collect EUR/USD exchange rate, you can use any resource such as Bloomberg, Google or Yahoo . However, using a resource with 4 decimal points will give you the best results showing a successful hedging at the end.

4. As of 6/29/2015, 2.5 mil Euros is worth $2,778,500. If your unhedged values differ more than $500,000 from this number, check your data and re-calculate.

5. How to calculate futures daily gains, cumulative gains is explained in page 26-27 or review Week 1 files.