# Foreign Exchange Risk Management Options part 3

 View all ACCA Paper P4 lectures >> This P4 lecture is based on OpenTuition course notes view/download here>>

1. says

Hi John, very insightful – thank you:

Quick question – confused as to why you would claim against the buy rate of the spot dollar

I.e 22 (Contracts) x £31,250 (size) x ( 1.4750 (right to sell ‘put option’) minus 1.4100 (today’s buy spot)

Why would claim against the buy spot rather than the Sell spot (1.4750 minus 1.4120), seeing as we bought the right to sell?

Why would anyone buy the option from you when the today’s spot is cheaper?

Many thanks

• says

We are not selling the option. The option is the right to sell £’s at a fixed rate (the exercise/strike price).

• says

Many thanks for the very prompt reply –

I think I get it: the original option was taken in the home country to sell the pound at an agreed rate (as we would need to get rid of the pound to buy the dollar in order to pay) – and we claimed this back as part of exercising the option – because our strike price was favourable to the April spot?

2. says

Good day Sir,

Many many thanks for these lectures, they have been very helpful indeed. However, there are no lectures for foreign currency and interest rate swaps, can you kindly advise on when these will be put on the website.

3. says

Hi tutor, I’m stuck in options concept, I’m sorry if it’s irritating to ask some topic, please solve this one, could u plz explain where am I wrong in the solved example (example from lecture 3 on currency options- open tuition course notes)
Payment \$1m

Option position £687500
Overhedged (£9959)
(31250x22x1.475
=\$1014063_\$1m
Overhedged by \$14063
Selling there dollars and get local £, so divide by 1.4120

• says

The difference between your total and the total in the answer at the back of the notes is GBP 30, which is irrelevant for the exam.
(The reason for it is the difference between the spot buy and sell rates at the date of the transaction. Strictly the method in the notes is the way it works in practice. The other way of doing it is effectively calculating the profit on the options based on 1.4120 instead of on 1.4100. However, that doesn’t matter in the exam – either way would get full marks. The reason I prefer the method in the notes is partly because it is the way it works in real life, but also because when you come to interest rate options there is no choice – it has to be done effectively that way).

4. says

ABC Inc, a USA based Co.is expected to make payment of £530000 in 3 months, 3 months spot (\$/£) 1.5655
strike price (£/\$) 1.58, premium 2.12 in cents, contract size £31250
Solution
Premium=\$11263, No of contracts are 17
Answer with BPP METHOD is \$848681
At spot rate \$829715
Claim back (\$7703)
(1.58_1.5655=0.0145x17x31250)
Net payment =\$833275
Where am I wrong?

• says

Firstly, either you have mistyped the question or BPP had made a typing error. The 3 month spot rate is quoted \$/GBP whereas the strike is quoted GBP/\$ – this could not be the case.

If I assume that the strike is really \$/GBP 1.58, then the option would not in fact be exercised – it would be cheaper to buy GBP’s at spot rather than at the strike.

Therefore, the end result would be to convert at spot (829715) and still pay the premium (11263) even though it was not exercised. This gives a total of \$840978.

(The BPP answer you type has wrongly assumed that the option is exercised. If they did exercise, then rather than receive back money on the option they would be having to pay in money (7730). This would result in a total payment of 829715 (at spot) + pay out 7703 (on the option) + pay out 11263 (option premium) giving a total of 848681- which is the same as the BPP answer.)

It either means that BPP have got it wrong, or somewhere you have mistyped the question.

• says

Ok thanks you, may be BPP misprinted
But if spot is 1.5655 and strike is 1.58, it’s the payment case so exercising the option is better or not?

• says

It is better to not exercise the option (because multiplying the GBP 500,000 by the spot rate will mean paying fewer \$’s than using the strike price).

5. says

I’ve used both types to solve a question, one that’s is in book and the one shown in lectures, but in some questions I don’t same get answers

6. says

Hi John,

Slightly confused on whether we needed to buy a call or put option. Is it the reverse in an FX option for an Interest Rate Option?

7. says

Thanks a lot sir. we appreciate your efforts to helps students. But sir Problem is that, in notes and books we have very basic example but in exam we are facing more complex question. how to handle this issue and from where we can find more material to practice.

• says

The lectures – as with all courses – go through the techniques needed.

The exam questions are not more complex in terms of the techniques, but certainly are more complex in terms of sorting through the information and deciding which techniques to use.
You can only master this by practicing exam-standard questions (once, obviously, you are happy with the techniques involved and really understand them) and for this – as we make clear throughout the website for all the exams – you must have a Revision/Exam Kit from one of the approved publishers, and you must work through all of the questions properly and learn from them.

If you have any problems with any of them (or with understanding the answers) then obviously ask in the Ask the Tutor Forum and we will try and help.

• says

Thanks a lot sir

8. says

Very useful lectures indeed..thank you..i could not find here lectures on SWAPS to hedge against excahnge risk…Why is it so??

• says

We do not have lectures on everything – some topics you have to study yourself from out notes and from your books.
New lectures are added as and when we have the time.

• says

(but please realise that we are doing all this in are spare time after work!)

• says

• says

No – sorry. However there is not much extra from what you will have learned for F9, and any extra techniques needed are covered in other chapters of the notes/lectures anyway.

9. Hi Sir,
I have problem in calculating cross rate,
Example, Consider the following.
\$/Pound sterling
Spot……………………One year forward rate
1.7985-1.8008………1.7726-1.7746
SF/Pound Sterling
Spot………………….. One year forward rate
2.256-2.298…………2.189-2.205
Now, What is the cross rate for converting SF to Dollars?

My second problem lie in foreign Tax credit, I don’t know how to calculate the value for Foreign tax credits.

Thank you for your continue support.

• says

1 SF will buy 2.298 GBP., and 1 GBP will buy 1.7985 USD.
So….1 SF will buy 2.298 x 1.7985 USD

With regard to tax credits, if (for example) tax has been charged at 25% in one country! and the profits are remitted to another country where the rate is 30%, then there is an additional 5% chargeable in this other country

10. says

Whether to buy Put Option or Call Option .I have tried to memorize following
US Company Receiving GBP (Any currency other than \$)- PUT ( Always)
US Company Paying GBP ( Any Currency other than \$)- CALL ( Always)
Non US Company Receiving – \$ – CALL ( Always)
Non US Company Paying – \$ – PUT ( Always)

Whether this is right way of doing and whether it would serve exam purpose.

11. says

Why do we convert the transaction at spot of 1.4100 when we are having the option and we can get the pounds at 1.4750?

• says

The lecture explains this!

These are traded options and so you do not actually have the right to convert at the option rate. What happens is that you convert at the spot rate and then ‘claim’ on the options and so get back the difference.
Watch the lecture all the way through – it is all explained.

• says

Oh ok.. I guess I missed that! Thank you so much!

12. says

Thank you to the tutor and Open Tuition for the wonderful lecture

However I have a q on the premium part.
The premium was initially established in \$ and since the company in q is a UK company, the impact should be shown in Pound and thus the need for conversion to Pound arises. I understood that part. However why was the the conversion rate used \$ 1.4850 (buying rate) and not \$ 1.4870 (selling rate) since we are selling \$ to receive pounds?

Thank you once again for a good lecture

• says

Hey I understood your question. And its a good one btw What i believe is, since its a premium PAYABLE in dollars, we have to BUY dollars to pay for the premium. And therefore, in order to buy the dollars, we are using the Buying Rate (1.4850).
So in short, we can say, we are selling 5556 pounds to buy 8250 dollars I hope i made sense 😀

• says

Wahabna is correct – because the premium is in dollars, we need to buy dollars.

13. says

Hi Markn, Thanks for your explanation. I finally understand that the tutor said, when we exercise the option, we are actually claiming back \$ from the option writer. So, the currency we hold now is \$, we will sell \$ to buy Pound. Therefore, buy rate of \$1.4120 is used. Anyway, thank you so much.

14. says

Hi Estherpang87, the reason he uses 1.4120 is because we are receiving the pounds to offset against the amount we are convering to pay the \$1m. Some tutors always advise us to choose the rate in which we receive less or pay more – it’s just an exam tip. Always choose a rate that is unfavourable to you…

15. says

Hi sir, in this example, when we calculate the amount attributable to option exercised, our working is [22 x 31250 x (1.475 – 1.4100)] / 1.4120 = 31649 pound.

In my opinion, the rate of 1.4120 is a buy rate. but in this case, we actually sell pound to buy \$ to settle payment. Shouldn’t we use sell rate of 1.4100, instead of the buy rate of 1.4120?

Thank you sir.

16. says

Dear Tutor, is it assumed that premium payable to bank in USD that’s why we are using buying ex.rate in this example? Thank you