Question

Hoodie Inc. in an Australian-based firm that is expecting to receive ¥ 4,000,000 Japanese Yen in 60 days. Over that time, Hoodie Inc. will be negatively affected if the Japanese Yen ____________ against the Australian Dollar. Therefore, they can hedge their exchange rate exposure by ______________. A. Appreciates; selling ¥ forward or buying put options on Japanese ¥. B. Depreciates; buying ¥ forward or buying call options on Japanese ¥. C. Appreciates; selling ¥ forward or selling put options on Japanese ¥. D. Depreciates; selling ¥ forward or buying put options on Japanese ¥. E. None of the options.

Answer 1

The answer to the question is OPTION D.

The justification for the same is that if the Japanese Yen Depreciates against the AUD, then the firm would be worse off in making payments in Yen. In other words if the firm has to pay in Yen then more Yen would be required for a particular payment.

Now in order to save from this depreciation the firm can presell the Yen in the forward market at the current spot rate. This means that no matter what the value of the Yen be after 60 days the firm will get the requisite currency in exchange for the Yen irrespective of the exchange rate because the firm had already entered in a forward contract where the price of exchange had been predefined.

The other alternative would be of buying a put option The reason is that put options have the quality that they increase in value when the underlying assets value decreases. Thus if the Yen depreciates then the value of the put option contract will increase. When they are exercised, put options provide a short position in the underlying asset. Because of this, they are typically used for hedging purposes or to speculate on downside price action