At 4pm, today, your company receives 6,250,000 Euros. If you convert 6.25 million Euros now, it will be USD 7,337,180. You are extremely happy with this current exchange rate and would take this US dollar value. But if you convert now, you have to pay a super high tax today.
Instead, you decide to convert to USD in 2 months and delay paying the tax. This delayed action comes with a big risk. Since EUR/USD exchange rate fluctuates every day, the US dollar value of your Euros in future will no longer be the same USD 7,337,180. This risk is called currency risk, aka foreign exchange rate (FOREX) risk.
The objective of this project is to design a strategy such that the conversion value stays as close to $7,660,542 throughout whole the sample period. The financial instrument is Euro FX futures contract expiring in December 2017.
10 Questions (each is worth 1 point, consider each as a rubric):
1. What is the difference between Euro FX futures and Eurodollar futures? Note that this question is not asking what the difference between Euro FX and Eurodollar is.
2. What is the contract size of the Euro FX futures contract? Is British Pound futures contract size the same as Euro FX futures contract size?
3. What action do you need to take with 12/2017 Euro FX futures today? Specifically, Long or Short? How many contracts? And most important. Explain why you have to take such position in detail.
The rest of this project will prove your action will actually work at the end.
4. For every trading day (no weekends/holidays) during the sample period, collect the daily EUR/USD exchange rate and Euro FX futures price. Create a spreadsheet and enter (1) date, (2) exchange rate, and (3) futures price.
Hint: If you do not want to collect these prices manually every day, see Note section at the end to learn where to find price history.
5. In the next columns, calculate daily gains and cumulative gains of your Euro FX futures position each day. Calculate these values in Excel. Do not manually enter the values. If I don’t see Excel command behind your answers, I’ll assume you copied someone else’s answers, which is not acceptable for an individual project. (very important, show calculations or otherwise I will assume you cheated)
6. Assume the initial margin requirement is $10,000 per contract and the maintenance margin requirement is $8,000 per contract. Calculate the margin account balance each trading day. Is there a margin call at any time? If yes, add the required cash to the margin account to avoid liquidation.
7. For each day, calculate the USD value of your 8.75 mil Euros (= unhedged position), In addition, calculate the values of your hedged position (= unhedged value + futures cumulative gain in Q5).
8. Plot the unhedged values and hedged values in Q7 over time. Calculate the standard deviations of the unhedged values and that of the hedged values from Q7.
9. Using your Q8 answers, answer whether your strategy in Q3 successfully lowered the exchange rate risk. If you have trouble with Excel plots, ask for help in Hangouts.
10. If FOREX increases, the USD value of 6.25M Euros will become higher, which benefits you. Suppose you want to enjoy this positive payoff opportunity but still want to hedge against FOREX drop. Which financial instrument will suit this purpose?
These solutions may offer step-by-step problem-solving explanations or good writing examples that include modern styles of formatting and construction of bibliographies out of text citations and references. Students may use these solutions for personal skill-building and practice. Unethical use is strictly forbidden.Answer 1:
Eurodollars refers to the time deposits which are held at banks outside the US, but are denominated in US dollars.
Eurodollar futures contracts are cash settled future contracts whose underlying instrument is the Eurodollar time deposit with 3 month maturity and principal value of $1,000,000
Eurodollar futures are used by entities to hedge against interest risk rate and secure interest rates for funds that it would be borrowing or lending in future.
Euro FX futures, on the other hand, are used to hedge the currency risk which is associated with exchange rate movements.
Unlike eurodollar futures, these contracts are settled through physical delivery.
The underlying instrument is the exchange rate between USD and Euro....
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