654 Part V: Index Options and Futures 
stock ownership. Moreover, he is able to establish that hedge at a much smaller com­
mission cost and with much less work than would be required to sell thousands of 
shares of stock. Similar thinking applies to all the cash markets that underlie futures 
contracts. The ability to hedge is important for people who must deal in the "cash" 
market, because it gives them price protection as well as allowing them to be more 
efficient in their pricing and profitability. A general example may be useful to demon­
strate the hedging concept. 
Example: An international businessman based in the United States obtains a large 
contract to supply a Swiss manufacturer. The manufacturer wishes to pay in Swiss 
francs, but the payment is not due until the goods are delivered six months from now. 
The U.S. businessman is obviously delighted to have the contract, but perhaps is not 
so delighted to have the contract paid in francs six months from now. If the U.S. dol­
lar becomes stronger relative to the Swiss franc, the U.S. businessman will be receiv­
ing Swiss francs which will be worth fewer dollars for his contract than he originally 
thought he would. In fact, if he is working on a narrow profit margin, he might even 
suffer a loss if the Swiss franc becomes too weak with respect to the dollar. 
A futures contract on the Swiss franc may be appropriate for the U.S. business­
man. He is "long" Swiss francs via his contract (that is, he will get francs in six months, 
so he is exposed to their fluctuations during that time). He might sell short a Swiss 
franc futures contract that expires in six months in order to lock in his current profit 
margin. Once he sells the future, he locks in a profit no matter what happens. 
The future's profit and loss are measured in dollars since it trades on a U.S. 
exchange. If the Swiss franc becomes stronger over the six-month period, he will lose 
money on the futures sale, but will receive more dollars for the sale of his products. 
Conversely, if the franc becomes weak, he will receive fewer dollars from the Swiss 
businessman, but his futures contract sale will show a profit. 111 either case, the 
futures contract enables him to lock in a future price (hence the name "futures") that 
is profitable to him at today's level. 
The reader should note that there are certain specific factors that the hedger 
must take into consideration. Recall that the hedger of stocks faces possible problems 
when he sells futures to hedge his stock portfolio. First, there is the problem of sell­
ing futures below their fair value; changes in interest rates or dividend payouts can 
affect the hedge as well. The U.S. businessman who is attempting to hedge his Swiss 
francs may face similar problems. Certain items such as short-term interest rates, 
which affect the cost of carry, and other factors may cause the Swiss franc futures to 
trade at a premium or discount to the cash price. That is, there is not necessarily a 
complete one-to-one relationship between the futures price and the cash price.