Question

Managing Transaction Exposures Assume the following information:

• Spot rate: CHF/USD = 0.7142
• 90-day forward rate: CHF/USD = 0.7114
• USD 90-day interest rate: 3.75% (APR)
• CHF 90-day interest rate: 5.33% (APR)

The option data for July contracts is given the table below.

Strike price (CHF/USD)	Call Premium	Put Premium
0.70	2.55¢ per CHF	1.42¢ per CHF
0.72	1.55¢ per CHF	2.4¢ per CHF

A. U.S. Company ABC, which exports to Switzerland, expects to receive CHF 450,000 in 90 days. Should Company ABC use currency derivatives to hedge transaction risk? If yes, which derivatives should Company ABC use? Please use a contingency graph to support your choices and computation. If no, please explain why
B. U.S. Company XYZ, which imports Swiss watches, needs to pay CHF 750,000 in 90 days. Should Company XYZ use currency derivatives to hedge transaction risk? If yes, which derivatives should Company XYZ use? Please use a contingency graph to support your choices and computation. If no, please explain why

Answer 1

Spot Price	1 CHF =	0.7142 USD
90 Day FWD Price	1 CHF =	0.7114 USD
Converting to USD
Spot Price	1 USD =	1.400168	CHF
90 Day FWD Price	1 USD =	1.4056789	CHF

Clearly USD is appreciating and CHF is decreasing.

Forward rate implied from spot interest rates is computed as -

1*(1+3.75%*90/360) USD = 1.400168*(1+5.33%*90/360) CHF

This implies, 1 USD = 1.40567 CHF.

FWD rate from interest rate is same as the traded FWD rate. So, there is no interest rate arbitrage he will get.

For question A,

We have to see the the trade off between Forward Contract and Options.

Since the US company ABC is an exporter to Swiss, and he gets in CHF. Since the dollar is appreciating, he gets less dollars per CHF. Either it can enter into a FWD to Buy Dollars for CHF or it can buy a Call option to sell CHF and get the dollars.

Using Fwd, ABC gets 1 CHF = 0.7114 USD.

Using Call Option,

ABC gets 1 CHF = 0.7 USD for a premium of 2.55 Cents per CHF.

Since, there is a premium of 2.55 cents CHF ABC has to pay, net cost is computed as,

1+2.55/100 CHF = 0.7 USD

=> 1.0255 CHF = 0.7 USD

=> 1 CHF = 0.6825 USD

or

ABC gets 1 CHF = 0.72 USD for a premium of 1.55 Cents per CHF.

Since, there is a premium of 1.55 cents CHF ABC has to pay, net cost is computed as,

1+1.55/100 CHF = 0.72 USD

=> 1.0155 CHF = 0.72 USD

=> 1 CHF = 0.7091 USD

When comparing both the Call options and a Fwd rate, ABC company is better off by selling a FWD to get 0.7114 USD per 1 CHF.

For Question B

We have to see the the trade off between Forward Contract and Options.

Since the US company XYZ is an importer from Swiss, and it need to pay in CHF. Since the dollar is appreciating, it gets more CHF per USD. Either it can enter into a FWD to Buy CHF per USD or it can buy a Put option to sell USD and get CHF.

Using Fwd, XYZ cost per 1 CHF = 0.7114 USD.

Using Put Option,

XYZ gets 1 CHF = 0.7 USD for a premium of 1.42 Cents per CHF.

Since, there is a premium of 1.42 cents CHF XYZ has to pay, net cost is computed as,

1 - 1.42/100 CHF = 0.7 USD

=> 0.9858 CHF = 0.7 USD

=> 1 CHF = 0.710083 USD

or

XYZ gets 1 CHF = 0.72 USD for a premium of 2.4 Cents per CHF.

Since, there is a premium of 2.4 cents CHF XYZ has to pay, net cost is computed as,

1 - 2.4/100 CHF = 0.72 USD

=> 0.976 CHF = 0.72 USD

=> 1 CHF = 0.7377 USD

Out of all the choices, Put option at the premium of 1.42 cents to sell dollars and get CHF is benefircial, as the net CHF cost is is only 0.7100 USD.

So, the company XYZ should opt for Put option here.