ABC, Inc., is a U.S.-based company incorporated in the United States for 5years. ABC, Inc. is a relatively small company, with total assets of only $300 million. The company produces only a single type of product. ABC has been quite successful in recent years. ABC Inc. needs to order raw material supplies two months prior to the delivery date. It is considering to order from a Japan that requires a payment of 50 million yen payable as of the delivery date and so the company has two choices 1) Buying one futures contract (which represents the 50 million yen). 2) Buying two call options contracts (since each option contract represents 25 million yen) The CFO favors the flexibility that options has over forward contracts since if the yen depreciates he can let the options be expired. He prefers to use a strike price which is about 5 percent above the existing spot rate to ensure that the company will not pay more than 5% above the existing spot rate while the transaction is two months beyond its order date, as long as the premium of option is no more than 1.6% of the price it would have to pay per unit when exercising the option. Generally, options on the yen require a premium of about 1.5% of the total transaction amount that would be paid if the option is exercised. For instance, recently the spot rate of yen was $0.0072, and the firm bought a call option having the strike price of $0.0075, that is 5% above the present spot rate. The premium charged for this option was $0.000113 that is 1.5% of the price to be paid per yen if the option is to be exercised. Because of a recent event there is more uncertainty about the yen's future value; however, it did not influence the spot rate or future or forward rates of the yen. The spot rate of yen was still $0.0072, but the option premium for a call option with a strike price of $0.0076 was now $0.00015. There was also another alternative call option available with the 2 month expiration date from now having the premium of 50.000113 which is the amount of the premium existing for the option desired before the recent event), but the strike price for this call option with an is $0.0079 As an analyst provide the insights on hedging and answer to the following questions.

You can use a spreadsheet if applicable.

1) Critique the hedging tools considered for this case in details. (25 Marks)

2) Assess a brief review of the literature on the usage of the hedging tools for small businesses such as ABC, Inc.. (25 Marks)

3) Appraise the choice of the call options discussing the tradeoff. (25 marks)

4) Evaluate a review of literature on leaving the transactions unhedged against using derivative to hedge the transaction risk. (25 marks)