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Forwards and options as hedging instruments

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USCom, a US computer manufacturer, will be delivering a large computer system to a German firm in six months. USCom expects to receive payment of €1.5 million at that time. Currently the spot rate is US $1.45/€, and the six-month forward rate is US $1.47/€. Suppose that the firm also has the following information from the options market:

  • Six-month call option premium is US $0.0195 per euro and the exercise price is $1.42,
  • Six-month call option premium is US $0.0005 per euro and the exercise price is $1.48,
  • Six-month put option premium is US $0.0012 per euro and the exercise price is $1.44,
  • Six-month put option premium is US $0.0032 per euro and the exercise price is $1.46.

a) Describe how USCom can hedge the currency risk with forwards and options. What are the differences between forwards and options as hedging instruments?

b) If in six months the spot rate is US $1.43/€, what are the profits and losses on the hedging strategies? What if the spot rate is US $1.48/€? Based on your calculations, which strategy is most preferable when you make the hedging decision and why?

Reference no: EM132611232

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