Evaluate alternative hedging strategies, Financial Management

Evaluate alternative hedging strategies, Financial Management

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Peak Inc. needs to order Canadian raw materials to use in its production process. The Canadian exporter typically invoices Peak in Canadian dollars. Assume that the current exchange rate for the Canadian dollar is $0.73/C$ and Peak needs C$100,000 in 90days. Two call options for Canadian dollars with expiration dates in three months and the following additional information are available:

Call option 1 premium on Canadian dollars =$0.015

Call option 2 premium on Canadian dollars =$0.008

Call option 1 strike price =$0.73

Call option 2 strike price =$0.75

One option contract represents C$50,000.

Peak can either (a) buy call options with the lower strike price, or (b) construct a bull strategy that involves buying the call option with the lower price and simultaneously writing the call option with the higher strike price. Further assume that sport exchange rate at the option expiration date is any of the following: $0.70, $0.73, $0.75, and $0.80.

Required:

a) Evaluate both hedging strategies relative to an unhedged position.

b) Repeat the exercise assuming that the spreader writes the option with the lower strike price and buys the option with the higher strike price. Note that it is the case of currency bear spread.

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