Question

answer the following

a. Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?

A. purchase a call option on francs.

B. sell a futures contract on francs.

C. obtain a forward contract to purchase francs forward.

D. all of the above are appropriate strategies for the scenario described.

b. If you have a derivative position where you might be obligated to buy Japanese yen, you are a:

A. Call option writer/seller

B. Put option writer/seller

C. Call option buyer/holder

D. Put option buyer/holder

c. Buying a currency option provides

A. a flexible hedge against exchange exposure.

B. limits the downside risk while preserving the upside potential.

C. a right, but not an obligation, to buy or sell a currency.

D. all of the above

Answer 1

a. US firm that will be receiving Swiss francs in the future will do the below to avoid exchange rate risk :

B) Sell a future contract on francs. This is because the firm will be receiving Swiss francs, selling a future contract is the only way to lock-in the rate to sell swiss francs amongst the choices given.

A call option will be purchased if the firm desires to buy swiss francs at a later date. Hence, this choice is incorrect in the given scenario. Similarly, forward contract to purchase swiss francs is not relevant in the situation, since the firm is already receiving swiss francs, it could have entered into a forward contract to sell the currency instead.

b. If I have a derivative position where I am obligated to buy Japanese yen, I am a :

B. Put option writer/Seller.

Only writer/seller of put/call option have the obligation to execute the transaction. Hence, option C and D are ruled out.

Call option writer gives the opposite party an option to purchase the underlying asset. Which means that the writer is under the obligation to sell. Whereas, the opposite is true for put option writer/seller, wherein the other party is having an option to sell the underlying asset which in this case is yen. Hence, as a put option seller, I am obligated to buy yen.

c. Buying a currency option provides :

D. all of the above

An option provides a right to enter into the transaction at a future rate depending on the spot price then, hence a currency option is a flexible hedge - since there is no obligation

It limits the downside risk, since the option holder has an option to execute the option contract to mitigate any loss if applicable. Also, this provides an upside potential

As explained above, a currency option buyer has a right but not an obligation to buy or sell the currency. Ofcourse, this comes for a price called premium.