FIN 5545 Project: Currency Exchange Rate Risk Hedge

Due date: 4/29/2018 (end of week 7, Sunday not Monday)

Submit 1 Excel file (or 1 Excel + 1 Word) to Canvas

Read the Notes section at the end. It will answer questions you may have.

The sample period for this project is from 3/19/2018 (today) to 4/20 (5 weeks). You will need to collect real-time data starting from today.

At 4pm, today, your company receives 12,500,000 Euros. If you convert 12.5 million Euros now, it will be USD 15,370,625. You are extremely happy with this current exchange rate and would take this US dollar value. But if you convert now, you have to pay a super high tax today.

Instead, you decide to convert to USD in 2 months and delay paying the tax. This delayed action comes with a big risk. Since EUR/USD exchange rate fluctuates every day, the US dollar value of your Euros in future will no longer be the same dollar amount. This risk is called currency risk, aka foreign exchange rate (FOREX) risk.

The objective of this project is to design a strategy such that the conversion value stays as close to \$15,370,625 throughout the whole the sample period. The financial instrument for this project is Euro FX futures contract expiring in June 2018.

10 Questions (each is worth 1 point, consider each as a rubric):

1. What is the difference between Euro FX futures and Eurodollar futures? Note that this question is not asking the difference between Euro FX and Eurodollar. It’s asking the difference between Euro FX futures and Eurodollar futures.

2. What is the contract size of the Euro FX futures contract? What about British Pound futures contract size? Are they the same?

3. What action do you need to take with 6/2018 Euro FX futures today? Specifically, Do you have to long or short? How many contracts? Explain why you have to take such position to hedge the currency risk.

The rest of this project will prove your action will actually work at the end.

4. For every trading day (no weekends/holidays) during the sample period, collect the daily EUR/USD exchange rate and Euro FX futures price. Create a spreadsheet and enter (1) date, (2) exchange rate, and (3) futures price.

Hint: If you do not want to collect these prices manually every day, see Note section at the end to learn where to find price history. The accuracy of the real price data will not affect the overall outcome of this project.

5. In the next columns, calculate daily gains and cumulative gains of your Euro FX futures position each day. Calculate these values in Excel. Do not manually enter the values. If I don’t see Excel command behind your answers, I’ll assume you copied someone else’s answers, which is not acceptable for an individual project.

6. Assume the initial margin requirement is \$10,000 per contract and the maintenance margin requirement is \$8,000 per contract. Calculate the margin account balance each trading day. Is there a margin call at any time? If yes, add the required cash to the margin account to avoid liquidation.

7. For each day, calculate the USD value of your 12.5 mil Euros (= unhedged position), In addition, calculate the values of your hedged position (= unhedged value + futures cumulative gain in Q5).

8. Plot the unhedged values and hedged values in Q7 over time. Calculate the standard deviations of the unhedged values and that of the hedged values from Q7.

9. Using your Q8 answers, answer whether your strategy in Q3 successfully lowered the exchange rate risk. If you have trouble with Excel plots, ask for help in Hangouts.

10. If FOREX increases in future, the USD value of 12.5M Euros will become higher, which benefits you. Suppose you want to enjoy this positive payoff opportunity but still want to hedge against FOREX drop. Which financial instrument will suit your purpose?

a.             Date

b.             EUR/USD exchange rate

c.              Euro FX futures price

d.             Your futures position daily gain

e.             Your futures position cumulative gain

g.             Unhedged value (= 12.5 mil Euros converted into USD)

h.             Hedged value (= unhedged value + your futures position cumulative gain)

IMPORTANT NOTES.

Note 1: For hints, review module 1, futures market. Specifically, daily settlement section to understand how daily gains/losses are accrued each day.

Note 2. Submit 1 Excel file with all your answers/tables/plots. You can submit multiple times. I will only grade the last submission. If you prefer, submit both Word and Excel files together in 1 submission.

Note 3. For any calculation question, you must do all the calculations in Excel. If I can’t see your calculations, I’ll assume you copied someone else’s answers.

Note 4. I highly encourage you to work in group. If you get lost, ask for help in group texting. You can even share the data and discuss results with your colleagues. Do NOT share your file or copy other’s answers. You must create your own Excel file from scratch. If I find 2 students sharing and copying answers, I’ll give F to both students.

Note 5. If you want to know whether your answer is right or wrong, don’t ask me in private. I can’t answer because it’s not fair to the rest of class. You will be better off asking in the group chat, where your colleagues and I can help.

Note 6. To collect Euro FX futures price every day, I recommend http://www.cmegroup.com. CME is the official exchange where futures are traded. Navigate and locate the relevant futures for this project. You only need to collect the “Last” price. Open, high, low prices are not needed.

Note 7. To collect EUR/USD exchange rate (FOREX), you can use any resource such as Bloomberg, Google or Yahoo. Each website may have slightly different rates, which is normal because of trading hours. For consistency, try to use the same source throughout. In the past, Bloomberg yielded the best results because it provides exchange rate upto 4 decimal points.

Note 8. Futures price and FOREX will not be identical to each other. But they should be very similar. If your FX futures price and FOREX differ by more than 10 cents, then it’s most likely your error.

Note 9.  https://www.quandl.com/data/CME provides price history of CME futures. You can use this database to collect the futures price data later instead of collecting the price every day from http://www.cmegroup.com. Navigate the website to locate the correct futures for this project. You can also download the data in Excel. Try it now to get familiar with the website before too late. Or find a nice classmate, who is willing to share the data.

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