Question

Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot rate of the British pound to be $1.49 in a year, so it decides to avoid exchange rate risk by hedging its receivables. The spot rate of the pound is quoted at $1.51. The strike price of put and call options are $1.54 and $1.53, respectively. The premium on both options is $.03. The one-year forward rate exhibits a 2.65 percent premium. Assume there are no transaction costs. What is the best possible hedging strategy and how many U.S. dollars Crown Co. will receive under this strategy?

Answer 1

Answer:

Sell pound forward

Explanation:

Forward rate = $1.51 *(1+2.65%) = 1.51 * 1.0265 = 1.55

Amount receivable in case of forward hedge = 100,000 * 1.55 = 155,000

Premium payable on put options = 100,000 * 0.3 = 3,000

Amount receivable in put options = 100,000 * 1.54 = 154,000

Net receivables in put options = 154,000 - 3,000 = 151,000

Conclusion: Higher amount is available in case of forward hedge. So, sell pound forward