Enviry Company, US-based company, has initiated biodegradable plastic by using agar to make packaging products to save the environment. Agar is a seaweed-based material used traditionally in Japanese culture. The team at Enviry Company has used it to manufacture an alternative to plastic, Agar Plasticity, with which they hope one day to replace all plastic-based packaging completely.

Recently, in producing Agar Plasticity, the company has ordered sufficient amounts of agars from Japanese supplier, AgarDe, which incurred Yen 25,000,000 with two months ahead of the delivery date.

The hedging strategies available are using options or futures contracts. In this regard, two call options and two put options contracts are available (each option contract represents Yen 12,500,000) as hedging approaches against Yen's movement with two months maturity. The current spot rate is $0.0093 per unit of Yen.

The first call options contract requires a premium of $0.004 per unit, and the exercise price is 5 percent above the spot rate. Meanwhile, an alternative call options is available with an exercise price of 10 percent above the spot rate, and the premium is $0.006 per unit. As for put options contracts, the first put options offers an exercise price of 4 percent above the spot rate with a premium of $0.003 per unit, while the second put options entails a premium of $0.007 per unit, with an exercise price of 11 percent above the spot rate. On the other hand, Enviry Company may choose futures hedge as an alternative hedge instrument. The futures price of the contract for the two months maturity is $0.0098.

i. Should AgarDe hedge its position in the above context? If yes, explain how. If no, explain why.

ii. Assume that Enviry Company shares the market consensus of the expected future spot rate equals to futures price of $0.0098. Given this expectation, calculate the total payoff as the result of the following strategy: -

a) Futures hedge 

 

b) Options hedge (there are three possible outcomes of using options contracts)