Question

a. What are currency options? What are the ways in which firms use currency call options?
      If you were a speculator how would you use a call option?

b. Country risk is a critical consideration in direct foreign investments. What does country
      risk analysis involve?

c. A call option on US dollar is available with a strike price of GHS 4.400. Sumaila, a

speculator, purchased the option for a premium of 0.2500 per USD. The USD spot rate on the day of expiration is 4.500.

a. Is the call option in the money? Explain.

b. How much profit/loss per unit did Sumaila make on this call option?

c. What is the net profit per unit to the seller of this call option?

Answer 1

Currency options are a mechanism to safeguard the risk of future currency fluctuations. It is a method to safeguard or hedge a current transaction risk with an optional right to buy or sell shares.

Currency call options are used by a firm to hedge the risk of

Currency exposure. For example let say a firm has imported good and is under an obligation to pay 1000 dollars by the end of 3 month. Now if the firm is expecting the currency to rise and lead it to pay a higher amount it may buy call option or an option to buy currency at a fixed price. Now if the currency rises in future the company can get the excess by selling it in market and thus hedging it's risk.

Basically an speculator is a person who earns from anticipating the movements in currency. If an speculator has an expectation that the currency value will rise in future, he will buy call option or right to buy currency at a fixed rate and as the currency rises he will exercise the same to earn the difference.