Question

A US company has bought a machine worth 3 million euros from a German manufacturer with payment due in three months. The treasurer finds that DeutscheUSA (a fictitious name), a large commercial bank, bids euros for $1.5000 and offers euros for $1.5010 in three months’ time. He readily agrees and locks in that price. Suppose DeutscheUSA would like to hedge its trade. It finds that a German importer hoping to buy 2 million euros worth of computer parts from the United States in three months’ time. They also agree to trade.

(a) What is the price risk exposure remaining for DeutscheUSA?

$1 million US dollars today

$2 million US dollars in three months’ time

3 million euros today

1 million euros in three months’ time

None of these answers are correct.

(b) What is DeutscheUSA’s profit and risk exposure after three months time?

a profit of $1,000 US dollars plus risk exposure on $2 million dollars

a profit of $2,000 US dollars

a profit of $2,000 US dollars plus risk exposure on $1 million dollars

a profit of $2,000 US dollars plus risk exposure on 1 million euros

None of these answers are correct.

Answer 1

a. Since , the US importer is expected to buy 3 million Euros from DeutscheUSA in three months time and the German importer is expected to sell 2 million Euros to DeutscheUSA in three months time, the net risk = 3 million - 2 million = 1 million Euros in three months time

Answer is 1 million euros in three months’ time

b. The risk is 1 million Euros. The net profit = 2,000,000*(1.5010 -1.5000) = $2,000

Answer is a profit of $2,000 US dollars plus risk exposure on 1 million euros