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Hello, I have a question about the option hedging part.
Since the question said that Frongoch Co needs to hedge a payment of €18,250,000 to a German supplier.
Also, Frongoch Co is an American company and the contract size is €125,000, I am little bit confusing that the contract size is EUR and it should sell the contract currency right?
So, if the transaction involves selling the contract currency, the company should buy the put option right?
But the answer was that Frongoch Co buy € September call options.
My question is whether the contract currency € (according to contract size) should look to the transaction payment/receipts € rather than the company’s local currency ($) to determine the put option or call option?
Because the US company supposed their payments or receivables would use the ($) but the contract size used (€), why it should use the call options instead of put option?
The transaction is paying €’s and therefore they need to buy €’s.
If using options, then since the contract size is in €’s they therefore want the option to buy €’s which means that they will buy call options.
(Have you watched my free lectures on the management of foreign exchange risk?)
Thanks a lot for your reply and explain, I understand now!
Maybe a lot of the past paper questions were receipts from customers… so I always remember selling it to the company’s local currency by put option if the contract size is different to the company used currency .
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