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Discuss and analyze the pros and cons of using forward contractsversus futures contracts for hedging purpose

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Keith Leannon
Keith LeannonLv2
28 Sep 2019

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Pls do not handwritten for easy reading

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Examine and discuss the difference between a loan commitment anda letter of credit. show example to support your answer

Today is May 2, and Bid and Ask are $1.2100/E and $1.2300/E. The August 21 and September 20 futures contracts are priced at is $1.2500 and $1.2600 respectively. Each contract controls 100,000E. You are receiving 418,000E in Euro revenues on September 9th. Assume that currently, the September 9th forward is $1.2560.

5. How would you properly hedge the revenues using futures contracts? Discuss why, how much you will be over or under-hedged, and the risks.
a. Buy 3 August Euro-futures contracts
b. Sell 3 August Euro-futures contracts
c. Sell 4 September Euro-futures contracts
d. Buy 4 September Euro-futures contracts
e. Sell 3 September Euro-futures contracts

6. If we properly hedge the above revenue, are we over-hedged or under-hedged, and what will cause the hedge to lose money? Explain why.
a. Over-hedged, an appreciation of the Euro relative to the forward
b. Over-hedged, a depreciation of the Euro relative to the forward
c. Under-hedged, an appreciation of the Euro relative to the forward
d. Under-hedged, a depreciation of the Euro relative to the forward
e. Nothing, the hedge will work perfectly

7. If on September 9th, the Bid and Ask are $1.2490/E and $1.2540/E, and the futures price is for the September 20 contract is $1.2550, did your hedge work perfectly, or did you make or lose money on the hedge?
a. Worked Perfectly (no gain or loss greater than $100)
b. Profit < $1000
c. Loss < $1000
d. Profit > $1000
e. Loss >$1000

8. Given the above results would we have been better off over-hedging or under-hedging? Retrospectively, (using the bid-ask and futures prices in problem 7) how many futures contracts should we have bought/sold to minimize gains and losses on the hedge (minimize hedge variance)?
a. Under-hedging; sell 3 contracts
b. Under-hedging; buy 3 contracts
c. Over-hedging; buy 5 contracts
d. Over-hedging; sell 5 contracts
e. Over-hedging; sell 6 contracts






9. Suppose instead that the resulting bid and ask are $1.2590/E and $1.2610/E, and the futures price is for the September 20 contract is $1.2620, (and you hedged using the proper number of contracts

1.One distinction between futures and forward contracts is

Forward contracts can be used to hedge and speculate, while futures contracts are only used for hedging purposes.

Forward contracts are highly standardized.

Futures contracts mark to market.

Futures contracts highly specialized.

2.

If the spot price for the pound in terms of dollars decreases over a given amount of time, the futures price for pounds (in terms of USD) would likely decrease over that same time period.

True

False

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