When you convert 5 mil Euros into USD next month, are you buying or selling Euros? To lock the future exchange rate in this case, should you long or short Euro FX futures today? Explain.
FIN 5545 Project:
Learning Objective: Apply Currency Futures to Hedge Exchange Rate Risk
Due date: 12/3/2023 (end of week 7)
This project is related to the following Course Learning Objectives and Module Learning Objectives:
CLO2. Describe the nature of financial derivative contracts.
CLO3. Manage market/currency/interest rate/credit risks using derivatives.
MO-1.2: Define futures contracts and analyze its role in financial market (CO2)
MO-1.4: Explain how futures contracts are traded (CO2)
MO-1.5: Apply index futures to hedge against stock market volatility (CO3)
Directions:
If you need help or need clarification, ask in Teams. Ill help you solve but will not confirm whether your answer is correct or not. For example, you can ask how do I calculate the daily futures gains? and Ill provide formulas and point you to the right direction. But if you ask Heres my excel. Is my answer correct?, I wont confirm it because its unfair to other students.
You must start from a fresh new blank Excel file. Do NOT share your Excel or copy others Excel. If I find 2 students submitting almost identical files, Ill give F to both students.
I am aware the solutions for previous projects are available online. I changed the questions for this semester. If you submit a project answering old questions, you will get an F.
Submit 1 Excel file with all your answers/tables/plots (preferably in 1 tab). You can submit multiple times to Canvas. Only the last submission will be graded. If you prefer to write up answers in MS Word, upload 2 files (Word and Excel) in 1 submission. Do not submit separately, as I only grade the last submission.
The sample period for this project is from 10/23/2023 to 11/24/2023 (5 weeks). You will need to collect real-time financial data starting from 10/23/2023.
On 10/23/2023, your company receives 5 million Euros for selling products in Germany. Currently, the EUR/USD exchange rate is 1.0614. So if you convert this 5 mil Euros to USD today, it will be worth $5,306,875. You are extremely happy with the current exchange rate and would take this US dollar value. However, if you convert now, you may have to pay tax today.
Instead, you decide to convert Euros to USD at the end of next month and delay paying the tax. However, this delayed conversion comes with a risk. Since EUR/USD exchange rate fluctuates every day, the US dollar value of your Euros next month will no longer be the same dollar amount today. This risk is called currency risk, aka foreign exchange rate (FOREX) risk.
The objective of this project is to design/execute a strategy today such that the USD value stays close to $5.3 mil throughout the whole sample period. The financial instrument for this project is Euro FX futures contract expiring in Dec 2023 (ticker: E6Z23 or /6EZ23).
10 Questions (each is worth 1 point, consider each as a rubric):
1. When you convert 5 mil Euros into USD next month, are you buying or selling Euros? To lock the future exchange rate in this case, should you long or short Euro FX futures today? Explain.
2. What is the contract size (aka. contract unit) of 1 Euro FX futures contract? Is the British Pound futures contract size the same as Euro FX futures? How many Euro FX futures contracts do you need to long/short today?
(Hint: Go to https://www.cmegroup.com (official futures exchange) and locate the Euro FX futures. Check Contract Specs tab.)
The rest of this project will confirm whether your actions taken on 10/23/2023 (=answers to Q1/Q2) are indeed the correct hedging strategy at the end. If you dont find sufficient evidence of lowering risk in Q3-Q10, its likely that your answers to Q1/Q2 are incorrect so revise your answers and solve them again, as necessary.
3. For every trading day (skip holiday/weekends) during the sample period, collect the EUR/USD exchange rate (from either Bloomberg, Google, Yahoo, Fed, etc) and the Euro FX futures price (from CME or other sites).
