HEDGING EFFECTIVENESS OF CURRENCY FUTURES CONTRACTS TRADED IN SIMEX

Abstract

The March 1973 changeover to floating exchange rates from fixed rates caused additional business risks to the international trading community in the form of exchange losses. An international business entity can cover its exchange risk in the forward market, the money market, and options and futures contracts available in many operating exchanges around the world. As in commodities, hedging can be done in currencies to reduce possible future losses. This hedging is particularly useful with currency futures contracts. Singapore is developing into an important financial centre. The Singapore Inter-national Monetary Exchange (SIMEX) started trading in West German mark (DM) and Japanese yen {yen) futures in September 1984 with a mutual offset arrangement with the International Monetary Market (IMM) of the Chicago Mercantile Exchange. This paper studies the hedging effectiveness of currency futures contracts traded in the SIMEX in the initial two years using one-week, two-week and four-week holding periods for contract maturities up to three months, three to six months and six to nine months. Two different approaches are considered: ( 1) Unadjusted Model and (2) Excess Return Model which are based on portfolio hedging theory for risk reduction given profit optimization motive. The results from this study were compared with results reported in the literature from similar studies done in the developed futures markets in the United States of America (USA).