ACCA AFM · Guided practice (Show me how)
Chapter 19: Foreign Exchange Risk Management (2)
Currency options: OTC and traded options on a payment
All exchange rates are dollars per pound. In a two-way quote the lower rate applies when buying dollars and the upper rate when selling them.
(a) It is 1 April. X plc expects a receipt of $2,000,000 on 30 June. Spot today is 1.5190. The company expects a favourable move but buys an OTC option to sell the receipt at 1.5200 for a premium of GBP 50,000, payable now. The spot rate on 30 June could be 1.5180 or 1.6153.
(b) A UK company must pay $1,000,000 in April. Spot now is 1.4850 - 1.4870. Traded sterling options have a contract size of GBP 31,250 and premiums in cents per pound:
| Strike | Call Mar | Call Apr | Call May | Put Mar | Put Apr | Put May |
|---|---|---|---|---|---|---|
| 1.425 | 6.29 | 6.32 | 6.49 | 0.02 | 0.14 | 0.45 |
| 1.450 | 3.81 | 4.17 | 4.54 | 0.03 | 0.48 | 0.98 |
| 1.475 | 1.53 | 2.45 | 2.92 | 0.13 | 1.20 | 1.84 |
Hedge using the highest listed strike. In April spot is 1.4100 - 1.4120. Use nearest whole contracts. In part (b), round dollar and sterling cash flows to whole units before the next step, as the notes do. Ignore financing interest on the premium.
(a) An OTC option: use it or not
State whether the OTC option should be exercised in each scenario on 30 June and calculate the net receipts.
(b) Set up the traded option hedge
Identify the traded option hedge and calculate contracts and premium for the April payment.
(b) The outcome in April
Calculate the total sterling payment in April when the option position closes.
Opening this exercise…