QUESTION: (2) If the importer decides to use the call option to hedge the exchange rate risk, describe the strategy. Specify the number of the contracts to hold and the cash flow to the importer in one years time. (7 marks)

Solution: Since the hedge ratio is 12. So the importer needs 500,000/100,000 * 2 = 10 contracts.

The PV of this portfolio is then given by:

When yen goes up, you exercise the call. Each call option earns $0.15/100 * 100,000 = $150. The total cost is then:

The strategy is to long 10 call.

500,000 $1.15 10 $150 + 10 $90.2876 1.05 = $4250 + $948.0198 100

= $5198.02

500,000 $0.85 + 10 $90.2876 1.05 == $4250 + $948.0198

MY QUESTION: The delta hedge is 1/2 but they say they need 5 contracts x 2 = 10 option contracts to hedge. Why is it multiplied by 2 ?