# Currency Exchange Rate Risk Hedge

The sample period for this project is from 10/25/2016 to 11/25/2016. You will need to collect real data starting from tomorrow.

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 over 5 weeks is 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 2016.

Your task for this project is to come up with a strategy today, 10/24/2016, and confirm that it actually worked befre due date.

10 Questions (each is worth 1 point, consider each as a rubric):

The first 3 questions should be answered today (but submit all the answers in 1 file later).

1. What is the difference between Euro FX futures and Eurodollar futures?

2. You are converting the currency in November but asked to use December expiring futures. Why can’t you use November expiring futures so that you can match the expiration? And what is the contract size of the Euro FX futures contract?

3. Are you selling or buying the 2.5 mil Euros next month? Given your answer to this, in order to hedge the exchange rate risk, what is correct strategy? Specifically, do you need to buy or short Euro FX futures? How many contracts?

The rest of this project is to confirm whether your strategy in Q3 actually works or not at the end. If you answered Q3 correctly, then the exchange rate risk should decrease significantly.

4. For every trading day (which means no weekends/holidays) during the sample period, collect the daily EUR/USD exchange rate and Euro FX futures price. If you do not want to collect these prices every day, see Note #2 at the end to learn where to find price histories. Create a spreadsheet and enter (1) date, (2) exchange rate, and (3) futures price.

5. In the next columns, calculate the Euro FX futures daily gains, and cumulative gains for each day. (Hint: Session 1) Make sure you are calculating these values in your Excel rather than manually inputting the results. If I don’t see any Excel command behind your answers, I’ll assume you copied someone else’s answers, which is not acceptable for an individual project.

6. Assume the initial margin requirement is $5,000 per contract and the maintenance margin requirement is $3,500 per contract. Calculate the margin account balance each trading day. Is there a margin call? If yes, add the required cash to the margin account to avoid liquidation. (Hint: Session 1)

7. For each day, calculate the USD value of your 2.5 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. Explain the different behaviors of each..

9. Calculate the standard deviations of the unhedged values and that of the hedged values from Q7. Discuss these 2 standard deviations.

10. Using your Q8, Q9 answers, confirm that your strategy in Q3 successfully lowered the exchange rate risk.

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