Treasury and Risk Management

This document provides information on treasury and risk management. It includes calculations for net profit/loss, explanation of futures hedge mechanism, and evaluation of hedge effectiveness. The subject is Treasury and Risk Management, and the document type is Study Material.

Running Head: Treasury and Risk Management
Treasury and Risk Management
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Treasury and Risk Management
Contents
A) Calculate the bank dealer’s net profit/loss after executing all her trades........................3
B) Explain the futures hedge mechanism for the firm and compute the company’s net
receipt on 19 December 2018. Explain if this hedge was effective...............................5
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Treasury and Risk Management
A) Calculate the bank dealer’s net profit/loss after executing all her trades. Ignore
margin considerations and other transaction costs (apart from the bid-offer
spread).
As the available contract is $1,00,000 so we need to consider opposite spot rates
USD/GBP and opposite positions in USD for the calculation of profit and loss:
GBP per
USD
(Spot,
mid-rates)
Trades
(Selling
and buying
USD
contracts)
Bid
(Spot
mid
rate -
0.0005)
Ask
(Spot
mid
rate +
0.0005)
T = 0 0.7843 Buy 5
contracts 0.7838 0.7848
T = 1 0.8000 Sell 8
contracts 0.7995 0.8005
T = 2 0.7918 Buy 4
contracts 0.7913 0.7923
T = 3 0.8013 Sell 6
contracts 0.8008 0.8018
T = 4 (19 December 2018) 0.7924 Buy 5
contracts 0.7919 0.7929
For any individual trade, Profit/loss is calculated by seeing the net effect after
covering positions taken in earlier trade.
For long position: Profit = (Present value of positions getting covered in the latest
trade) - (Starting value of the positions that are now getting covered)
For Short position: Profit = - [(Present value of positions getting covered in the latest
trade) - (Starting value of the positions that are now getting covered)]
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Treasury and Risk Management
Total profit in GBP: GBP 14,309.60
Or, total profit in USD = USD that can be bought with GBP 14,309.60 = (Total GBP
profit of 14,309.60) * (Broker ask rate of 1.265 USD per GBP) = $18,065.87
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Treasury and Risk Management
B) Explain the futures hedge mechanism for the firm and compute the company’s
net receipt (in its local currency) on 19 December 2018. Explain if this hedge was
effective.
The British company had to receive a fixed amount of dollars at a future date, so the
company was at risk if GBP (local currency) strengthened or USD (foreign currency)
weakened. Because in that case, it would have received less amount of GBP (local
currency) for the fixed dollar amount it was getting from its foreign customer.
Therefore, the company entered into futures contract to sell USD 10,00,000 for a
fixed amount of GBP.
In mid-June 2018:
In terms of GBP per USD-
Number of USD/GBP futures contracts, company will short = $10,00,000/$83,313 =
12.
Therefore, the company’s net receipt in its local currency on 19 December 2018
= GBP 7,43,494.
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Spot rate for USD per GBP: 1.3330
GBP/USD futures contract size: GBP 62,500
GBP/USD futures for delivery of USD per GBP on 19 December
2018: 1.3450
Spot rate for GBP per USD: 0.7502
USD/GBP futures contract size: $83,313
USD/GBP futures for delivery of GBP per USD on 19 December
2018: 0.7435

Treasury and Risk Management
Explain if this hedge was effective:
Spot price in mid-June, USD per GBP was 1.3330
So, the spot rate for GBP per USD in mid-June 2018 was 1/1.330 = 0.7502
And, at mid-June spot rate: 10,00,000 USD was equal to GBP 7,50,188
Spot price on 19 December 2018, USD per GBP was 1.2620.
So, spot rate for GBP per USD, on 19 December 2018 was 1/1.260 = 0.7924.
If the company had not entered into the futures contract, then it would have sold the
USD amount from its customer at the current spot rate on 19 December 2018.
Then at the spot rate on 19 December 2018, total GBP it would have received for
10,00,000 USD was GBP 7,92,393.
Hence, if it had remained unhedged then the equivalent GBP amount would have
grown from 7,50,188 to 7,92,393 that is a rise of GBP 42,205.
The company’s net receipt in its local currency on 19 December 2018, in case of the
futures contract was GBP 7,43,494.
In the hedged scenario, the equivalent GBP amount grown from 7,50,188 to 7,43,494
that is a rise of GBP -6,693.
As the foreign currency strengthened during this period so the company would have
received more funds in terms of local currency if it had not entered into the futures
contract. As described by the above calculations the hedge proved to be
ineffective.
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Treasury and Risk Management
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