Question

Question 1:

Using the following information please to answer the question below.

You are reviewing your clients (Based in United Kingdom) hedging strategy for the cash flows it expects to obtain from sales in the US during the calendar year 2019.

Revenue: $90,000

Cost of sales: £54,000 (Expenses are billed in GBP)

Exchange Rate Bid Ask

Spot rate (Scenario 1) Bid: $1.45/£ Ask: $1.465/£

Spot rate (Scenario 2) Bid:$0.88/£ Ask: $0.9/£

Options contact:

Option Premium £0.025

Option Strike price £0.922

What are your client's profits if you hedged using options contracts in scenario 1 and 2 compared to not hedging?

Answer 1

scenario 1 :

In scenarion 1. Profit earned with hedging (pound 26,905) is more and we had to deduct the loss of option premium which was paid ,calculated on option strike price.

In scenario 2,

Profit earned without hedging (pound 46,000) is more.

The Strike Price of pound 0.922 is at option premium of pound 0.025 .

Note : We have made our calculation , after first converting exchange rate in $ terms because we want our calculation in pounds so, in order to convert revenue from $ to pounds we first bring exchange rate into dollar form , only then we do profit calculation in pound.

In Exchange rate two way quote , where 2 currencies are given , while converting excahange rate of bid and ask from pound to dollar we have to reverse the calculations .

Also , note that Bank and Ask rate are quoyed from bank's point of view.