Hedging with currency optionPresentation Transcript
International Finance – GSM 658
“A foreign currency option contract is a financial
instrument that gives the holder the right but not
the obligation to sell or buy currencies at a set
price either on a specific date or before some
(The Theory and Practice of International Financial Management, Click and Coval, 2002)
◦ Potential transactions
◦ Transactions that depend on something else
◦ Uncertain demand
Limit downside risk, but reap most of the upside.
◦ The right to buy a currency at the strike price
◦ Used to hedge foreign currency outflows
◦ The right to sell a currency at the strike price
◦ Used to hedge foreign currency inflows
Contract Size = 10,000 foreign currency units
(1,000,000 Yen) (Source: http://www.phlx.com/products/wco_faq.html#3)
Expiration, the third Friday of the expiration month.
American Options – Can be exercised ANYTIME
European Options – Can ONLY be exercised at
American or European?
Pace Co, a cheese and wine store in Salem, OR
has placed a €20,000 bid for a very rare wine from
France on March 18. The results of the auction
will not be known until May. The management
team at Pace Co is worried that the Euro will
continue its recent appreciation and would like to
lock in an exchange rate so that the cost of the
auction does not get out of hand without having to
commit to a contract. What should they do?
Pace Industrials based in Salem, OR has placed a
bid with the Australian government to be one of
the sub-contractors to build a bridge to Tasmania
for AU$2,000,000. The winning bid will be
selected in June (they will be paid at that time).
The management team is concerned that the
Australian dollar may depreciate and wants to lock
in an exchange rate incase they receive the
contract. What should they do?