Croissant, a french company expects to pay US$1,200,000 to a US supplier in late November. It is now late July, and the current spot exchange rate is €1 = $1.2200. September and December dollar-euro currency futures are currently being traded at $1.2165 and $1.2170 respectively. The company wants to hedge its exposure with currency futures. The Euro futures are available for a standard quantity of 125000 and the tick size is 0.0001. (i) Explain how Croissant might establish a hedge against exchange rate risk. (ii) Suppose that in November when the dollars are paid, the spot rate has moved to 1.2040 and the futures price is 1.2030. Show the outcome of the hedge and calculate the effective exchange rate. (iii) Comment on the basis risk if any.
Croissant, a french company expects to pay US$1,200,000 to a US supplier in late November. It is now late July, and the current spot exchange rate is €1 = $1.2200. September and December dollar-euro currency futures are currently being traded at $1.2165 and $1.2170 respectively. The company wants to hedge its exposure with currency futures. The Euro futures are available for a standard quantity of 125000 and the tick size is 0.0001.
(i) Explain how Croissant might establish a hedge against exchange rate risk.
(ii) Suppose that in November when the dollars are paid, the spot rate has moved to 1.2040 and the futures price is 1.2030. Show the outcome of the hedge and calculate the effective exchange rate.
(iii) Comment on the basis risk if any.
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