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A company based in Farland (with the Splot as its currency) is expecting its US customer to pay $1,000,000 in 3 month’s time and wants to hedge this transaction using currency options.
What is the option they require?
1 A Splot put option purchased in America
2 A US dollar put option purchased in Farland
3 A Splot call option purchased in America
4 A US dollar call option purchased in Farland.
A 2 or 3 only
B 2 only
C 1 or 4 only
D 4 only
A is the right answer but i can,t get any logic behind it specially when it comes to buying it in different countries.Where they buy the option is of no real relevance.
They are receiving $’s and therefore need to sell $’s to buy Splots.
Therefore they need either to buy a $ put option (i.e. an option to sell $’s at a fixed rate) or alternatively to buy a Splot call option (i.e. an option to buy Splots at a fixed rate).
Ok i got it but please tell me when calculating a dollar value of a money market hedge why we chose the deposit rate of a home country and use a borrow rate of a foreign country.
Below is the extract.I solved this question already and 5%(2.5%for 6 months) was a borrow rate)and 4%(2% for 6 months) was a deposit rate.“Zigto Co is a medium-sized company whose ordinary shares are all owned by the members of one family. The domestic currency is the dollar. It has recently begun exporting to a European country and expects to receive €500,000 in six months’ time. The company plans to take action to hedge the exchange rate risk arising from its European exports.
Zigto Co could put cash on deposit in the European country at an annual interest rate of 3% per year, and borrow at 5% per year. The company could put cash on deposit in its home country at an annual interest rate of 4% per year, and borrow at 6% per year”They are receiving €’s and therefore in order to be able to convert today they need to borrow €’s now.
They convert today to $’s, and so they then deposit the $’s for 3 months.Have you watched the free lectures on money market hedging?
@johnmoffat said:
They are receiving €’s and therefore in order to be able to convert today they need to borrow €’s now.
They convert today to $’s, and so they then deposit the $’s for 3 months.Have you watched the free lectures on money market hedging?
I think you made a mistake.For 6 months or 3 months?
I did not watch your lectures but i studied a BPP text.
I understood all that but the question was why we have to use the borrowing rate of a foreign country and depositing rate of a domestic country?
In the question the available borrowing and deposit rates were different for domestic and a foreign country.Yes, sorry, I did mean 6 months.
But the whole point of money market hedging is to borrow in one currency and deposit in the other!! There would be no point in doing it otherwise.
And obviously the interest rates will be different in the two countries (and although you did not ask this, that is precisely why the forward rates are different from the spot rates – it is the interest rates that determine the forward rates.)
Sorry, but if you can’t be bothered to watch my lectures, then you really can’t expect me to keep typing out bits of them here! (I have been teaching F9 for far longer than anybody working at BPP 🙂 )
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