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Suppose that you (i.e., company XYZ) are a US-based importer of goods from Canada. You expect the value of the Canada dollar to increase against
Suppose that you (i.e., company XYZ) are a US-based importer of goods from Canada. You expect the value of the Canada dollar to increase against the US dollar over the next 6 months. You will be making payment on a shipment of imported goods (CAD100,000) in 6 months and want to hedge your currency exposure. The US risk-free rate is 5% and the Canada risk-free rate is 4% per year. The current spot rate is $1.25/CAD, and the 6-month forward rate is $1.3/CAD. You can also buy a 6-month option on Canadian dollars at the strike price of $1.4 /CAD for a premium of \$0.10/CAD. Suppose Canada company gave XYZ a choice of paying either CAD100,000 or $125,000 in six months. If the spot exchange rate in six months turns out to be $1.3/CAD, which currency (USD or CAD) do you think XYZ will choose to use for payment? The value of this free option for XYZ is $
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