Suppose a company will receive US$2, 000, 000 in three months and they wish to hedge the foreign exchange rate risk associated with this payment.
The spot exchange rate is $1 = euro 0.70.
They estimate that if the US dollar falls by euro 0.10 (i.e. to $1 = euro 0.60) then the company will lose euro 200, 000 on the transaction.
i) If the current three month futures price is $1 = euro 0.78 and dollar futures contracts are for $100, 000 each, how should the company hedge its position?
ii) Demonstrate that the hedge is perfect by illustrating net payoff for a euro 0.10 fluctuation in exchange rates from current spot prices.