T7 FFM Hedging Using Currency Futures

Currency Futures Hedging Steps
📌 Hedging using currency futures involves four primary steps: determining whether to buy or sell futures, identifying the number of contracts needed, matching the timing/maturity, and calculating the resulting profit or loss.
🔎 To determine action (buy/sell), consider the contract currency and the need for the currency (e.g., if you need USD and the contract is in USD, you buy the future).
🔢 The number of contracts is calculated by dividing the amount to be hedged by the value of one contract.

Example 1: Hedging a Future Euro Payment (US Company buying German Goods)
🇪🇺 A US company needs to buy €750,000 in 90 days. Since they need to buy Euros, they must buy Euro Currency Futures.
📈 If the spot rate moves unfavorably (Euro strengthens), the company makes a profit in the Futures Market (e.g., selling higher than the purchase price) which offsets the higher cost in the cash market.
⚖️ A perfect hedge is achieved when the timing (maturity date), the amount hedged, and the price convergence align.

Example 2: Hedging a Future USD Receipt (UK Company selling to Singapore)
💷 A UK company receives USD 1.8 million but needs to convert it to Pound Sterling ($\text{£}$). The contract currency is $\text{£}$, so they need to buy $\text{£}$ Futures (meaning they sell USD to acquire $\text{£}$).
💱 When calculating the number of contracts, the USD receipt must first be converted into the contract currency ($\text{£}$) using the prevailing spot rate before dividing by the contract value.
📉 Even if the cash market rate moves favorably (requiring less USD to buy $\text{£}$), the loss incurred in the Futures Market (due to the hedge) adjusts the total cost, resulting in the same effective locked rate.

Imperfect Hedging Scenarios
⏳ Imperfect hedging occurs when there is a mismatch in timing (e.g., needing currency in 30 days but only 3-month contracts are available).
🎚️ Over-hedging occurs if rounding results in buying slightly more contracts than mathematically required (e.g., $5.76$ contracts rounded up to $6$ in one example, or $5.76$ contracts rounded down to $5$ in another exam-based rule mentioned).
📉 In imperfect hedging, the effective rate achieved will not perfectly match the initial Futures rate used for the transaction.

Key Points & Insights
➡️ To select the correct spot rate (bid/ask), determine if you are buying or selling the currency and remember banks buy high and sell low.
➡️ Profit/loss in futures is calculated by multiplying the difference in rates (or total ticks) by the contract value and the number of contracts.
➡️ The ultimate goal of currency hedging is to lock the effective exchange rate, meaning the net cost is stabilized regardless of spot market fluctuations.

📸 Video summarized with SummaryTube.com on Jan 03, 2026, 04:11 UTC