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May I ask that when recommending a hedging strategy (when there is no indication what future rates will be) is it best to show the results of options assuming the option is not exercised? This will then give the worst case position and can be compared against other methods.
Or is it best to predict what the futures price will be and therefore show the position of the options are exercised?
for example in the June 2011 question, the answer for the futures method predicts what the futures price will be (by not using lock in rate) but then in the options method it doesn’t show the profit on the options by using the predicted futures rate.
It confuses me why in the futures method the examiner predicts what the futures price will be but then on the options method, it ignores the predicted futures method and assumes that both options are left to expire, when at least 1 option should be exercised when using the predicted future price.
I hope this makes sense
Regards
RobertWith options, if the question tells you what the spot rate is on the date of the transaction (which these days is less likely) then you can show exactly what happens.
Otherwise it is best to show what will happen if the option is exercised because this is the worst outcome.
No – the worst outcome is what happens when the option is exercised.
If the exchange rate (or the interest rate) moves in our favour, then we will not exercise the option and the result will be better.
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