A Note On Currency And Index Futures

An investor can limit his/her incoming and outgoing cash flows in one currency with respect to another currency by purchasing (long hedge) or selling (short hedge) foreign exchange futures. A person dealing in foreign exchange is exposed to exchange risk, since the cash flow in terms of domestic currency will be known only at the time of conversion. To hedge, a person who has taken a long position or is expected to do so in a foreign currency, should sell futures in the foreign currency against the domestic currency. Similarly, a person who has taken a short position or is expected to do so in a foreign currency, can create a hedge by buying futures in the foreign currency against the domestic currency instead of buying the currency later in the spot market.

Example:

A US exporter is exporting goods to his German client. On January 27, 2003, the exporter got the confirmation from the German importer that the payment of Euro 800,000 will be made on March 1, 2003.
In this case, the US exporter is exposed to currency fluctuations. If the Euro depreciates there will be loss on his dollar receivables^[7] . To cover this risk the exporter can sell a Euro futures contract.