Question

a. What a company should do to hedge foreign currency that will be received or paid? Explain your answer.

b. What are advantages of futures options over spot options?

c. What does vega measure? What can you tell from vega value? Can the vega of a derivatives portfolio be changed by taking a position in the underlying asset? Explain your answer.

Answer 1

Ans a)

Hedging Against  foreign currency exposure: There are various way a firm can hedge against foreign currency exposure

• Natural Hedge: Hedge Against Export receivable Pay to Import requirement of the same maturity and amount.
• Through Forward Booking: Booking a forward contract and locking the future price as power own convenience,
• Through Options Booking: Using Currency Options and Futures as per requirement a firm can hedge its foreign currency exposure.
• Through Money Market Instruments: Firm can hedge by money market Instruments by discounting its export proceeds and taking advantage of interest difference between two currencies.

Ans b)

Advantage of Futures is over spot is

• futures are traded in exchanges for spot/commodity etc.
• For futures a trader can get leverage i.e. paying a notional amount will be able to take a large exposure.
• Hedging against future proceeds/portfolios using futures.

Ans c)

• What does vega measure: Vega is type of Option geek. It measures the change in Option price with respect to change in Volatility of Underlying assets.
• A higher vega value of options tells that higher sensitivity of the options price with a change in underlying assets. It helps a trader to choose to take exposure in which options and calculate future risk/profits based on future underlying assets price.
• Can the vega of a derivatives portfolio be changed by taking a position in the underlying asset: No because Vega of an underlying asset is always "Zero". So taking any no of position in underlying assets will not affect portfolio total Vega.