QUESTION

MITISHAMBA Co$.,$ a USA$-$based company specializing in the supply of medical equipment to both the USA and Europe, finds itself on November $30,2023,$ engaging in a recently finalized deal with a Swiss customer. The agreement involves the sale of CHF$12\mathrm{.}3$ million worth of medical equipment, with the customer scheduled to make payment on May $31,2024.$ To mitigate the foreign exchange risk associated with this transaction, MITISHAMBA Co$.\text{'}$s Treasury Department aims to employ traded futures or options to the fullest extent possible. Any portion of the transaction value not covered by a futures or options contract will be hedged using the forward market.

Exchange rates $($quoted as US$$/$CHF $1)$

Spot $1\mathrm{.}0292-1\mathrm{.}0309$

Three months forward $1\mathrm{.}0327-1\mathrm{.}0347$

Six months forward $1\mathrm{.}0358-1\mathrm{.}0380$

Current futures $($contract size CHF $125,000,$ futures price quoted as US$ per CHF$1)$

Futures price:

December $1\mathrm{.}0318$

March $1\mathrm{.}0345$

June $1\mathrm{.}0369$

Currency options

Contract size CHF $125,000$

Exercise price quotation US$ per CHF$1$ Premium: US cents per CHF$1$

Calls Puts

Exercise Price December March June December March June

$1\mathrm{.}0375$

$0\mathrm{.}47$

$0\mathrm{.}50$

$0\mathrm{.}53$

$0\mathrm{.}74$

$0\mathrm{.}79$

$0\mathrm{.}86$

Futures and options contracts reach maturity at the end of each month.

Comments from the Non$-$Executive Director

A recently appointed Non$-$Executive Director has been briefed on the operations of the Treasury Department and has raised several inquiries about the hedging activities. He aims to comprehend the importance of basis risk concerning futures and seeks insights into the notable characteristics of over$-$the$-$counter forward contracts and options. Additionally, the director is curious about why MITISHAMBA Co$.$ leans towards utilizing exchange$-$traded derivatives for hedging.

The Non$-$Executive Director has also been introduced to the concept of the mark$-$to$-$ market process and desires an understanding of the associated terminology and procedures, using the sale transaction with the Swiss customer as an example. The Treasury Department has provided pertinent information to address these inquiries. The contract specifications for the CHF futures contract specify that an initial margin of US$$1,450$ per contract is mandatory, along with a maintenance margin of US$$1,360$ per contract. The tick size on the contract is US$$0\mathrm{.}0001,$ and the tick value is US$$12\mathrm{.}50.$ For the purpose of analysis, it is assumed that on the initial day when MITISHAMBA Co$.$ holds the future contracts, the loss per contract amounts to US$$0\mathrm{.}0011.$

REQUIRED:

Assess which of the exchange$-$traded derivatives would yield a higher receipt for MITISHAMBA Co$.,$ taking into account scenarios involving the exercise and non$-$ exercise of options.

Examine the advantages and disadvantages for MITISHAMBA Co$.$ when using forward contracts in comparison to over$-$the$-$counter currency options. Explain the reasons MITISHAMBA Co$.$ might prefer exchange$-$traded derivatives over over$-$ the$-$counter derivatives for mitigating foreign currency risk.

Clarify to the Non$-$Executive Director how the mark$-$to$-$market process operates for the CHF futures, elucidating the significance of the data provided by the Treasury Department.