It is March 1, 2021. You work as a financial analyst for Umbrella Corporation in Trenton, New Jersey. Dr. James Marcus, CEO, has arranged for the purchase of a British gene sequencing system. The equipment will cost 75 million and is due in Pounds Sterling, one year from now on March 1, 2022. Dr. Marcus is concerned about the foreign exchange exposure of this upcoming payment. Especially during the last 12 months, currency market volatility has been high, fueled mostly by uncertainty about the potential weakness of the US dollar. State Street Bank in Boston offers the following spot rate and 12 months forward points1 : Spot ( $/ ) 1.3930 / 1.3940 12 months ( $/ ) 15 / 20 (.0015 / .0020) You look at Bloomberg for interest rates to calculate a money market forward alternative: Euro Dollar Interest Rates 12-months 0.25 % / 0.28 % Euro Sterling Interest Rates 12-months 0.12 % / 0.14 % You call the Bank of New York Mellon (BNYM) and ask for one year 1.3950 $/ strike call option to buy 75 million. BNYM quotes the following one year offer price for you to buy the option. One year call option on Pounds (exercise price) 1.3950 $/ Percentage of $ amount at exercise price 5.33 %

d) Umbrella does not use futures contracts to hedge, but to make your report complete, you want to include a section on Pound currency futures and the steps Umbrella would take to hedge the exposure. Describe how futures could be used to hedge this risk. Assume the currency futures market for the Pound is fairly priced. Explain in detail the implementation of this hedge and the cash flows / transactions you would have to make on day one and at the time of the account payable if you were to use a futures hedge. (E. Which futures exchange? F. How many contracts would you buy or sell? G. How much margin you would need to post? When would you put on and remove the hedge, how/when would you pay the account payable, etc.)

Answer rating: 100% (QA)

To hedge this exposure using futures Umbrella Corporation would take the following steps A The futur... View the full answer