An FI must make a single payment of 500,000 Swiss francs in six months at the maturity of a CD. The FI’s in-house analyst expects the spot price of the franc to remain stable at the current $0.80/SF. But as a precaution, the analyst is concerned that it could rise as high as $0.85/SF or fall as low as $0.75/SF. Because of this uncertainty, the analyst recommends that the FI hedge the CD payment using either options or futures. Six-month call and put options on the Swiss franc with an exercise price of $0.80/SF are trading at 4 cents and 2 cents per SF, respectively. A six-month futures contract on the Swiss franc is trading at $0.80/SF.
a. Should the analyst be worried about the dollar depreciating or appreciating?
b. If the FI decides to hedge using options, should the FI buy put or call options to hedge the CD payment? Why?
c. If futures are used to hedge, should the FI buy or sell Swiss franc futures to hedge the payment? Why?
d. What will be the net payment on the CD if the selected call or put options are used to hedge the payment? Assume the following three scenarios: the spot price in six months will be $0.75, $0.80 or $0.85/SF. Also assume that the options will be exercised.
e. What will be the net payment if futures had been used to hedge the CD payment? Use the same three scenarios as in part (d).
f. Which method of hedging is preferable after the fact?