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QUESTION 2

A US exporter has made a 3 month 60m loan at 5% interest. The US exporter wants to hedge its position in the futures market. The following Sterling-Dollar Futures contract (for 3 month delivery) is available:

Contract size = 62,500 Futures price = 1.2814 (meaning 1 = $1.2814) The current spot exchange rate is 1.3257 (GBP/USD = 1.3257)

(b) Discuss whether the US exporter should buy or sell the futures contracts.

(c) Calculate the number of the futures contracts that the US exporter should trade.

(d) Suppose that, in 3 months time, the following rates hold: Spot exchange rate = 1.2857 and (3 months) Futures rate = 1.2614

(i) Compute the gain or loss on the cash position.

(ii) Compute the gain or loss on the futures position.