Hedging with a bear spread (refer to Chapter 11). Marsden Ltd has customers in Canada and frequently receives payments denominated in Canadian dollars (C$). The current spot rate for the Canadian dollar is £0.50.

Two call options on Canadian dollars are available. The first option has an exercise price of £0.47 and a premium of

£0.02. The second option has an exercise price of £0.49 and a premium of £0.01. Marsden Ltd would like to use a bear spread to hedge a receivable position of C$50,000, which is due in one month. Marsden is concerned that the Canadian dollar may depreciate to £0.48 in one month. (Refer to Appendix 12 in this chapter.)

a Describe how Marsden Ltd could use a bear spread to hedge its position.

b Assume the spot rate of the Canadian dollar in one month is £0.48. Was the hedge effective?