Example 1.1 Hedging with forward contracts It is May 13, 2015. ImportCo must pay 10 million on August 13, 2015, for goods purchased from Britain. Using the quotes in Table 1.1, it buys 10 million in the three-month forward market to lock in an exchange rate of 1.5742 for the pounds it will pay. ExportCo will receive 30 million on August 13, 2015, from a customer in Britain. Using quotes in Table 1.1, it sells 30 million in the three-month forward market to lock in an exchange rate of 1.5736 for the pounds it will receive.

Discuss how foreign currency options can be used for hedging in the situation described in Example 1.1 so that (a) ImportCo is guaranteed that its exchange rate will be less than 1.5900, and (b) ExportCo is guaranteed that its exchange rate will be at least 1.5500.