FIN 5545 Project: Currency Hedge, Due date: 12/7/2015 (end of week 7)

The sample period for this project is from 10/27/2015 to 11/27/2015.

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 fluctuates every day, the US dollar value of your 2.5 mil Euros in the future uncertain, which is called exchange rate risk. Your objective is to lower this exchange rate risk. You decide to hedge against this risk using EUR/USD (=Euro FX) futures contract expiring in December 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 November. But why do we need to use December 2015 futures instead of November 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. If you do not want to collect these prices every day, see hint #2 below. Create a spreadsheet and enter dates and both prices.

5. Calculate the Euro FX futures daily gains, and cumulative gains for each day using the position you answered in Q3.

6. Assume the initial margin requirement is $5,000 per contract. Calculate the margin account balance each day. Is there a margin call, when the maintenance margin requirement is $3,500 per contract? If yes, add the required cash to the margin account to restore initial margin account requirement.

8. For each day, calculate the value of your unhedged position (= 2.5 mil Euros in US $), and the values of your hedged position (= unhedged value futures cumulative gain in Q5).

9. Plot the unhedged values and hedged values in Q8 over time. In addition, calculate the standard deviations of the unhedged values and that of the hedged values in Q8. 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 day: 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. In the past, Bloomberg gave the best results because it provides exchange rate upto 4 decimal points.

4. As of 10/26/2015, 2.5 mil Euros is worth $2,756,625. 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.

6. If you get lost, ask for help in Hangouts. You can even share the data and discuss results.

7. We already learned all the tools to do the calculations. As you collect the data, attempt this project. If you wait till week 7 to answer, you may forget how to solve.