Question

1. The three-month futures price for the British pound is $1.3160/£. You expect the spot price three months from today to be $1.2690/£. The British pound futures contract size is £62,500. a. If you are a speculator would you buy the futures contracts or short (sell) them. Explain your answer in your own words. b. How much profit would you make if you trade 62 contracts and your expectations come true? c. If you were an MNC with A/R (accounts receivables) of £24 million due in three months that you want to hedge, would you buy or sell the pound futures. Explain your answer in your answer in your own words. d. How many contracts would you be able buy or sell? How much would be your pound A/R worth in dollars?

Answer 1

a. If I am a speculator, I am expecting the spot price to be less as compared to the futures price. I will short sell the futures. Short selling the futures at a price higher than the expected spot price will enable me to book a profit.

b. Size of 1 contract = £62,500

Profit on 62 contracts = 62* 62,500 * ($1.3160 - 1.2690)

Profit on 62 contracts = 62 * 62,500 * $0.047

Profit on 62 contracts = $182,125

c. If the amount of £ 24 million were due in 3 months, I would sell the pound futures. Here is why:

I am expecting to receive £ 24 million in 3 months.

I am also expecting the spot price 3 months from today to be $1.2690/£ but the futures for 3 months are available at $1.3160/£ .

This means that, I am expecting the amount of a £ to fall. Thus, the decision to sell the futures is apt.

d. Calculation of number of contracts to be sold

Number of contracts = £ 24,000,000/62,500 = 384 contracts

Worth of pound in dollars shall be 384 * 62500 *1.3160 = $31,584,000