UVW, a U.S. company, will be paid £1.30 million by a British company next month. It...

UVW, a U.S. company, will be paid £1.30 million by a British company next month. It wishes to protect the payment against a drop in the value of the British pound. To achieve this goal, UVW can either enter into a 30-day short futures position to sell the British pound at a price of $1.6512/£, or it can buy pound put options with a strike price of $1.6610/£at an option premium of $0.02/£. The spot price of the British pound is currently $1.6560/£, and the pound is expected to trade in the range of $1.6200 to 1.7000. UVW’s treasure believes that the most likely price for the British pound in 30 days will be $1.6400. Suppose the futures contract and options contract are of the same size of £65,000.
1. a) How many futures contracts will UVW need to protect its receipts? How many options contracts?
2. b) Tabulate UVW’s profit and loss associated with the put option position and the futures position for the following pound prices at expiration: $1.6200, $1.6400, $1.6512, $1.6610, and $1.7000. Ignore transaction costs and margins.
3. c) Tabulate the total cash flow to UVW using the options and futures contracts, as well as the unhedged position for the following pound prices at expiration: $1.6200, $1.6400, $1.6512, $1.6610, and $1.7000.
4. d) What is UVW’s break-even point of future spot price on the futures contract? On the options contract?
  
  e) Compare the two strategies.

Expert Solution

Under option contracts,

Profit earned by the US company may extend to any extent when sale is made outside.

Loss suffered by the company is limited to premium only.

Under future contracts,

Profit or loss depends on futures price fluctuation.

jeff jeffy answered 2 years ago

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