It is June. An exporter expects to receive $90,000 in September, which he wishes to convert to Japanese yen. This gives him a three-month period of FX risk and uncertainty.

Since the exporter has fixed costs that he will need to pay, he wishes to hedge the FX risk to ensure he can meet his obligations and retain his profit margin. The FX risk is therefore that the price of the Japanese yen strengthens, meaning that the $90,000 purchases less yen in September than it would purchase today. This objective can be achieved with Micro USD/JPY FX futures (Globex product code M6J).

For the purposes of this scenario, let’s assume the following:

Buying one contract is equivalent to buying USD in exchange for JPY. Selling the futures is equivalent to selling USD in exchange for JPY.

In the current example, it is assumed that the exporter will receive a fixed USD amount, and that the exporter has a base currency of Japanese yen and will wish to convert US dollars into Japanese yen.

To hedge the exposure, the exporter will sell Micro USD/ JPY futures contracts. In effect, this is selling USD in September to buy JPY in September. As the price of USD/JPY fluctuates in the near term, the hedger will realize profits in his futures account to offset a stronger yen or realize losses in his futures account to offset a stronger USD. Either way, the position will ensure that the amount of yen he gets for $90,000 is fixed at current levels.

Trading in the Micro USD/JPY futures terminates on the second business day prior to the third Wednesday of the contract month.[1] This would make September the appropriate futures contract month to hedge this transaction since the CME Micro USD/JPY contract is listed and active in quarterly calendar months.

The number of FX futures needed to hedge the transaction can be calculated by considering the currency exposure. The exporter expects to receive USD 90,000 which he will wish to convert to JPY.

The futures price, quoted in Japanese yen per US dollar, is JPY 109.15 per USD. The expected income will be JPY 9,832,500. The contract size of the CME Micro USD/JPY futures contract is US $10,000, therefore, to hedge the FX exposure, the exporter needs to sell nine futures.

We can examine what might happen to this hedged position in different outcomes.  

An appreciation of the JPY versus the USD can also be viewed as a decrease in the value of USD, measured in JPY. In this example, we assume an appreciation of the JPY such that the price of the September futures contract goes from JPY 109.15 per USD to JPY 108.25 per USD, which represents an appreciation of 0.8%. 

In cash market, $90,000 has a JPY value of JPY 9,742,500, which is less than expected had the exchange rate not changed. This lower outcome is offset by a gain made on the FX futures position. Overall, the cashflow has been maintained in line with expectations, which is the purpose of the hedging strategy.

A depreciation of the JPY versus the USD can also be viewed as an increase in the value of USD, measured in JPY. In this example, we assume a depreciation of the JPY such that the price of the September futures contract goes from JPY 109.15 per USD to JPY 110.25 per USD, which represents a 1.0% depreciation.  

In cash market, $90,000 in this scenario has a JPY value of JPY 9,922,500. This is higher than expected had the exchange rate not changed. The Micro USD/JPY futures hedge position records a loss of JPY 99,000 offsetting the gain which maintains the overall return from the transaction.

In the example given above, the exporter’s base currency was assumed to be JPY and the price to be fixed in USD. Similar hedging strategies would apply for the case where the price was determined in JPY and the exporter’s base currency is USD. In the latter case, the exporter would need to hedge the JPY and this could be hedged once again by buying CME Micro USD/JPY futures contracts as in the example shown.

The FX hedging strategy shown is also applicable in cases where an exporter has the FX exposure in USD arising from positions in financial derivatives denominated in different currencies.

The volatility in foreign exchange markets can also be an unpredictable factor that firms are looking to hedge. By hedging foreign exchange risk, companies can stabilise future cash flows which in turn creates greater confidence in business performance.

The CME suite of Micro FX futures includes a number of key foreign exchange futures contracts and these are providing participants with effective hedging tools to manage growing risks in the sector.

Salient features of the futures contracts discussed in this article.

¹ See https://www.cmegroup.com/trading/fx/e-micros/micro-usd-jpy_contract_specifications.html.