Nutourne Co will have a Swiss Franc receipt in six months' time and needs to hedge against the dollar strengthening.
Futures
Sell Swiss futures and use June futures contracts.
No. of contracts
= CHF12,300,000/125,000
= 98·4, say 98, hedging CHF12,250,000
Remainder to be hedged on the forward market is CHF12,300,000 - CHF12,250,000 = CHF 50,000
Receipt = CHF50,000 x 1·0358= $51,790
Calculation of futures price
Assume that basis reduces to zero at contract maturity in a linear fashion.
Estimate from March and June futures contract rates.
Predicted futures rate at the end of May
= 1·0345 + ([1·0369 - 1·0345] x 2/3) = 1·0361
Expected receipt = CHF12,250,000 x 1·0361 = $12,692,225
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Or
Calculation of futures price
Alternatively, use spot rate = 1·0292
Predicted futures rate at the end of May
= 1·0292 + (6/7 x (1·0369 - 1·0292))
= 1·0358 (when the June futures contract is closed out in May).
Expected receipt = CHF12,250,000 x 1·0358 = $12,688,550
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Options contract
Nutourne Co would purchase CHF June put options.
Number of contracts 98, as before.
Amount not hedged, hedged by forward contract CHF translated as $51,790 as before.
Assuming the options are exercised:
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Workings
1) Receipt
CHF125,000 x 98 x 1·0375 = $12,709,375
2) Premium
1·0375 options = 98 x 125,000 x 0·0086 = $105,350
The options would give the higher receipt if they were not exercised and the spot rate moved sufficiently in Nutourne Co's favour. If Nutourne Co allowed the option to lapse, it would obtain the same receipt as under the futures if the US$/CHF spot rate was x, such that:
12,692,225 = 12,250,000x - 105,350
12,250,000x = 12,692,225 + 105,350
so that x is US$1·0447 = CHF1.
Or
12,688,550 = 12,250,000x - 105,350
12,250,000x = 12,688,550 + 105,350
so that x is US$1·0444 = CHF1.
Comments
If the options are exercised, the futures would give the higher receipt. The options give a lower receipt because of the premium which Nutourne Co has to pay. The futures will be subject to the risk that basis (the difference between the futures price and the spot price) may not decrease linearly as the futures approach maturity as assumed in the above calculations. This will mean that the hedge of the CHF 12,250,000 is imperfect, and the receipt may be unpredictable despite a futures hedge being taken out.
The options can also be allowed to lapse if for some reason the contract is not completed. If this happens, Nutourne Co will only have to settle the forward contract.
