An Australian bank must pay US$10 million in 90 days. It wishes to hedge the risk in the futures mar

An Australian bank must pay US$10 million in 90 days. It wishes to hedge the risk in the futures market. To do so, the bank should: Select one: a. Sell AUD 10 million in US dollar futures b. Buy USD 10 million in US dollar futures c. Sell USD 10 million in AU dollar futures d. Buy AUD 10 million in US dollar futures e. Buy USD 10 million in AU dollar futures
Answer & Explanation
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Answer; b. Buy USD 10 million in US dollar futures

Step-by-step explanation
Hedging is a technique for risk management used to offset investment risks by taking an opposite role in a similar asset. Usually, the decrease in risk given by hedging often results in a decrease in future income. Usually, hedging policies include derivatives, such as options and futures contracts, it is a way of reducing risk exposure by taking an offsetting position in a security. If the bank uses futures contracts as part of their hedging strategy, their purpose is to reduce the risk that the underlying asset, typically a security or another financial instrument, will incur a loss due to an adverse shift in the market value. Therefore if the bank has to pay US$10 million in 90 days it means that it has to buy USD 10 million in US dollar futures so as to hedge the risk in the futures market.

References

(PDF) Futures and forward contract as a route of hedging the risk. (2016, July 12). ResearchGate. Retrieved November 26, 2020, from https://www.researchgate.net/publication/288228197_Futures_and_forward_contract

Hagelin, N., & Pramborg, B. (2004). Hedging foreign exchange exposure: risk reduction from transaction and translation hedging. Journal of International Financial Management & Accounting, 15(1), 1-20.

Pirchegger, B. (2006). Hedge accounting incentives for cash flow hedges of forecasted transactions. European accounting review, 15(1), 115-135.