Managing Exchange Rate Risk with Derivatives: An Application of the Hedge Ratio

Risk management practices have become increasingly sophisticated. Derivatives have been developed and they can be widely used by economic agents in order to effectively hedge the risk, or by those who want to speculate on the evolution of prices. This study presents a hedging alternative with future contracts using an ARMA/ARIMA model. Employing five futures contracts on several exchange rates - AUD/CAD, EUR/JPY, EUR/USD, GBP/USD, RMB/USD - the actual value of the base at a future time (defined as the difference between spot rate and futures rate) can be predicted with a certain number of days until maturity. Apart from the classical calculation of the hedge rate this is another method for hedgers to use in order to reduce the volatility of their positions by trying to predict the future spot price in the currency market.