Economic exposure (e.g., circumstances where a companys market position stands to be hurt by foreign competition if its currency rises in value in relation to others).

The three most favored currency options strategies include:

BUYING AN OPTION. Allows unlimited upside potential and caps downside exposure. SELLING AN OPTION. Caps upside potential but allows unlimited downside exposure. Buying an option and selling a put provides the hedger with a comparable outcome. For instance, buying a dollar call against a yen implies that the buyers could exercise the option by buying dollars and paying yen. Alternatively, by buying a yen put against dollars, the hedger could exercise by delivering yen and getting paid dollars. Both options require that the hedger pays yen and obtains dollars. BUY-SELL OPTIONS. Caps upside potential and downward exposure, and it is generally obtained at zero cost. Devising Hedging Strategies The Assignment You are a member of Chase Options, Inc., who was asked to participate in designing hedging strategies for the following transactions:

Anticipated Currency Transactions

A U.S. company expects DM 100 million in repatriated profits from its German subsidiary on March 20, 199 The company believes that the dollar has reached a long-term low at the current level DM/$6700; however, it doesnt want to lock in a forward exchange contract because of uncertainty concerning the impact of the German reunification on the currency market. The company doesnt want to exchange at greater than DM/$7000 (e.g., 7200). Design a hedging strategy by using currency options and utilizing the rates available in Table 1 (Row 1). Examine the implications of hedging instead with a forward contract. Consider whether strategy (III) B (3) listed below is applicable for this transaction. Utilize the date in Table 1 (Row 2). A U.S. firm has bought industrial equipment from a U.K. firm for 5 million payable in 60 days. The firm believes that UKs political and economic uncertainty might drive the pound sterling down significantly. Design a hedging strategy for the corporation by employing either forward currency contracts or currency options and utilizing the data listed in Table 1 (Row 3). Uncertain Currency Transactions A U.S. fund manager who bought 100 million in Australian dollar (A$) bonds when the A$ was at US$/A$0.72 is worried that the A$ might depreciate because of disappointing Australian economic performance. He decides to set A$/$0.72 as the maximum downside loss that he wants to risk from the current level of A$/$0.7850 (spot). The fund manager doesnt mind foregoing profit opportunities from a further upward move in the A$ and is uncertain how long he will hold the bonds. He sets the year end as his time horizon. By utilizing Table 1 (Rows 4 and 5) data, which hedging strategy should the fund manager adopt? Solve A German company is bidding on a contract in the U.K. The bid is estimated at 40 million and they anticipate a profit margin of 30 percent on the project. Hence, they will need to repatriate 12 million in profit, but they worry that the new U.K. economic trends could hurt the pound sterling exchange rate. Determine how the German company could hedge their potential exposure. Utilize Table 1 (Row 6) for data. Economic Hedging In late 1987 American Motors Corporation (AMC) believed that with the yen exchange rate at /$120 the corporation was competitive vis--vis its Japanese rivals. However, if the dollar is to rise again, AMC believed that it could lose 510 percent of its sales for every 10 percent strengthening of the dollar. Propose a hedging policy for AMC by utilizing the data in Table 1 (Row 7). What is the cost of your recommendation and what is the companys breakeven point? Solve Cross Hedging Multinational corporation B has borrowed DM to finance expansion of its German subsidiary. The German subsidiary sells 89 percent of its products to an Italian customer who pays in lira. Company B is exposed to the depreciation of the lira and the appreciation of the DM. Design a hedging strategy for the parent.

7. Multinational corporation B has lira sales, but because of high interest rates on lira denominated funds, hedging with lira options could be less favorable than hedging with DM options. Which hedging strategy would you consider as the most feasible? Solve