Question

Assume that the transactions listed in the first column of the following table are anticipated by U.S. firms that have no other foreign transactions. Place an “X” in the table wherever you see possible ways to hedge each of the transactions.

            1.   Georgetown Co. plans to purchase Japanese goods denominated in yen.

            2   Harvard, Inc., sold goods to Japan, denominated in yen

3.   Yale Corp. has a subsidiary in Australia that will be remitting funds to the U.S. parent.

4 Brown, Inc., needs to pay off existing loans that are denominated in Canadian dollars.

Princeton Co. may purchase a company in Japan in the near future (but the deal may not go through).

                 Forward Contract                    Futures Contract                    Options Contract

               Forward         Forward                  Buy               Sell                  Purchase       Purchase

               Purchase           Sale                  Futures          Futures                  Calls              Puts  

      a.                                                                                                           

      b.                                                                                                                                

      c.                                                                                                                                 

      d.                                                                                                           

      e.

Answer 1

Let us see each case separately.

1. a)Georgetown is the US Company & it has to Purchase goods from Japan in YEN, It means it has a risk of YEN rising or US $ falling. So to hedge itself from the risk it has to buy the Foreign currency(YEN) at a Forward rate.(b)Now since the concept of Forward & Futures are similar, that is why it can hedge itself by entering into a Long Position in Future Contract. (c) In option contract also the firm will buy a call option because if the Foreign currency increases then we can enjoy it by exercising the call option and if it decreases then Option will lapse.
2. Harvard sold goods to japan, it means it has Foreign currency receivable and hence it is afraid of YEN falling or US $ rising. So it can hedge in this way:- (a) Sell the Forward contract (b) Short the Future contract (c) Buy a Put option. NOTE:- This part is reverse of the first part and hence the explanation is also opposite of the explanation given in the first part.
3. Yale co. has a Subsidiary in Australia which will remit the funds i.e. AUD to its parent in US. So it means that Yale has AUD(Foreign Currency) receivable that means it is afraid of AUD falling or US $ rising. So appling the same concept of Part 2 the answer will bw same as in part 2.
4. Brown Inc. has CAND(Foreign Currency) payable that means that it is afraid of CAND rising or US $ falling. So the concept is same as in Part 1 hence the answer is also same as part 1.
5. Princeton co of US is in a process of buying a company of Japan. However the acquisition is not final, so it is uncertain that any outflow will occur in the future that is why it is not viable to enter into a Forwrd contract. However since there is no initial investment in Future Contract hence it can go LONG on Future Contract as it has FC payable. Similaly in case of option buying the buyer has to pay a Premium amount based on the outflow, so if the US co. wants it can buy into a call option by paying the premium amount.