Forward and Futures Hedging, Spread, and Target Strategies Essay

3025 Words 13 Pages
CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD, AND TARGET STRATEGIES

END-OF-CHAPTER QUESTIONS AND PROBLEMS

1. (Short hedge and long hedge) Another type of hedge situation is faced when a party plans to purchase an asset at a later date, such as a bread maker. Fearing an increase in wheat prices, the bread maker would buy futures contracts. Then, if the price of wheat increases, the wheat futures price also will increase and produce a profit on the futures position. That profit will at least partially offset the higher cost of purchasing wheat. This is a long hedge, because the hedger, the bread maker here, is long in the futures market. Because it involves an anticipated transaction, it is sometimes called an anticipatory hedge.
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The third approach is to identify the spot transaction that you will undertake at the end of the hedge. The futures transaction at the end of the hedge will then be the opposite of this spot transaction. Given this futures transaction, do the opposite futures transaction today.

6. (Short Hedge and Long Hedge) a. The firm is exposed to the risk of a falling stock market. Thus, to profit it would need to execute a short hedge.

b. The investor is exposed to the risk of the bond price rising. Thus, to profit he would need to execute a long hedge.

c. The firm is long the currency and is exposed to the risk of a fall in the value of the currency. Thus, to profit it would need to execute a short hedge.

7. (Foreign Currency Hedges) The exposure is to 100,000(SF225) = SF22,500,000. The dealer would like to lock in the cost in dollars. Thus, he could buy 22.5 million Swiss francs in a forward contract at the rate of $0.3881 with an expiration of August 16. When the contract expires, it does not matter what the spot rate is as the 22.5 million Swiss francs are purchased at the contract rate of $0.3881. Thus, the total cost is (22,500,000)($0.3881) = $8,732,250.

8. (Foreign Currency Hedges) The bank currently holds a long position in Canadian dollars, worth

5,000,000($0.7564) = $3,782,000

and needs to protect against a decline in the value of the Canadian dollar.

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