Page 207 - AFM Integrated Workbook STUDENT S18-J19

Hedging foreign exchange risk

Question 3

JP Co is a US company. It has agreed to sell some goods for €12 million to a
customer based in the Eurozone.

It is currently 30 November and the customer will pay for the equipment on 31
March. The spot rate of exchange is US$ 1.2250 – US$ 1.2280 to €1.

JP Co is looking to hedge the foreign exchange risk on this transaction using
traded currency options.

Market information:

Currency options (Contract size €250,000, Exercise price quotation: US$ per
€1, Premium: US cents per €1)

Calls Puts

Exercise price December March December March

1.2000 0.92 1.04 1.00 1.09

1.2200 0.32 0.65 1.94 2.58

Required:

Calculate the US$ value of the transaction, on the assumption that it is
beneficial to exercise the option on 31 March.

Solution

Set up hedge

Call or put options? CC is €. We are selling €. So put options.

Number of contracts = €12,000,000/€250,000 = 48

Which expiry date? March, since it matches the transaction date exactly.

195