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MACT9160 Derivative Securities: Exchange Rate Fluctuations

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MACT9160 Derivative Securities

Questions:

This assessment aims to provide with  an opportunity to analyse  various investment alternatives based on the respective risk and return so as to choose the most appropriate investment opportunity.

You are expected to read beyond the textbook and be able to apply the knowledge gained from real life examples either from your working  environment  or/and  case  studies  read,  and  are able  to demonstrate  your competence in the areas indicated in the questions. You are encouraged to provide specific in-depth comments instead of general comments.

Individual Assignment

Imagine it is 10 July 2020. A UK company has a US$6.65m invoice to pay on 26 August   2020. They are   concerned   that   exchange   rate fluctuations could increase the £ cost and, hence, seek to effectively fix the £ cost using exchange traded futures. The current spot rate is $/£1.71110. £/$ futures, where the contract size is denominated in £, are available on the CME Europe exchange:

September expiry – 1.71035

December expiry – 1.70865

The contract size is £100,000 and the futures are quoted in US$ per £1. The contract specification for the futures states that the tick size is 0.00001$ and that the tick value is $1.

Outcome on 26 August:

On 26 August the following was

True: Spot rate – $/£ 1.65770

September futures price – $/£1.65750

In the scenario above the CME contract specification for the £/$ futures states that an initial margin of $1,375 per contract is required. The maintenance margin is $1,250 per contract. The settlement prices for this future are:

Settlement price on 11 July (Friday) 1.70925

Settlement price on 14 July (Monday) 1.70805

Settlement price on 15 July (Tuesday) 1.71350

Required:

  1. Determine the net cash flow using the futures hedge ignoring the requirements of the initial margin and the maintenance margin.
  2. Determine the daily balance in the margin account.

MACT9160 Derivative Securities

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