Page 140 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 8: Currency Futures and Currency Options

Notes
Per Unit Per Contract
Selling price of pound $1.50 $48,000 ($1.50 × 32,000 units)
–Purchase price of pound –$1.40 –$44,800 ($1.40 × 32,000 units)
–Premium paid for option –$.04 –$1280 ($.04 × 32,000 units)
=Net profit $.06 $1920 ($.06 × 32,000 units)
Assuming that the seller of the put option sold the pounds received immediately after the
option was exercised, the net profit to the seller of the put option was:

Per Unit Per Contract
Selling price of pound $1.40 $44,800 ($1.40 × 32,000 units)
–Purchase price of pound –$1.50 –$48,000 ($1.50 × 32,000 units)
–Premium received +$.04 +$1280 ($.04 × 32,000 units)
=Net profit –$.06 –$1920 ($.06 × 32,000 units)
The seller of the put options could simply refrain from selling the pounds (after being forced to
buy them at $1.40 per pound) until the spot rate of the pound rose. However, there is no
guarantee that the pound will reverse its direction and begin to appreciate. The seller’s net loss
could potentially be greater if the pound’s spot rate continued to fall unless the pounds were
sold immediately.
Whatever an owner of a put option gains, the seller loses, and vice versa. This relationship
would hold if brokerage costs did not exist and if the buyer and seller of options entered and
closed their positions at the same time. However, brokerage fees for currency options exist and
are very similar in magnitude to those of currency futures contracts.
Problem 1:
1. Assume that a MNC ABC Ltd. would like to execute a money market hedge to cover a
¥250,000,000 shipment from Japan of music systems it will receive in six months. The
current exchange rate for yen is ¥124/$.

(i) How would ABC Ltd. structure the hedge? What would it do to hedge the Japanese
yen it must pay in six months? The annual yen interest rate is 4%
(ii) The yen may rise to as much as ¥140/$ or fall to ¥115/$. What will the total dollar
cash flow be in six months in either case?
Solution:
(a) ABC Ltd. must go for “hedging currency risk through the purchase of currency options”.
To offset the risk, the company should purchase 180 days Yen call options.
OR
It can also be structured like this:

(i) Borrowing ¥ that amount so that 250,000,000 ¥ received can be used to offset the loan
(ii) Convert and Invest in $, Repay the yen loan in 180 days.
Amount to be borrowed = 250000000/1.02= 245,098,039¥
Dollar Investment = US$ 1976597
Interest to be Paid = 4901961¥

LOVELY PROFESSIONAL UNIVERSITY 135