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Suppose that you are expecting to receive 100 million euro in three months and you want to hedge against the exchange rate risks when you

Suppose that you are expecting to receive 100 million euro in three months and you want to hedge against the exchange rate risks when you convert euro into dollar later. In the currency options market, two types of 90-day options are available (in the table). Assume that one unit of option is 100 mil euro.

Euro option

Strike price

Premium

Put (right to sell euro)

1.1 $/euro

0.05 $/euro

Call (right to buy euro)

1.12 $/euro

0.05 $/euro

(1) Which option would you use to hedge against the exchange risks? How does your $ revenue at maturity depend on the future spot rate (use graph with the amount of US dollar received when you use this option on Y axis and $/euro exchange rate on X-axis).

(2) The use of options has a disadvantage of having to pay premium now. However, by combining buying and selling of call and put options, you can hedge without incurring premium payment now (option collar). Explain how you can use option collar for the transaction in question (1). Draw graphs as in (1)

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