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4 June, 18:30

Corona Co. is expecting to receive 100,000 British pounds in one year. Corona expects the spot rate of 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% premium. Assume there are no transaction costs. What is the best possible hedging strategy and how many U. S. dollars Corona Co. will receive under this strategy

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  1. 4 June, 22:14
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    1st strategy : Selling pound forward

    The spot rate of the pound is quoted at $1.51.

    The one-year forward rate exhibits a 2.65% premium.

    The one-year forward rate = 1.51 (1 + 0.0265)

    = $ 1.55

    Dollars received = 100000 * 1.55 = $155000

    2nd strategy : Buying put option

    The strike price of put = $1.54

    premium on option is $.03

    Amount received per option = $ 1.54 - $ 0.03 = $1.51

    Total Dollars received = 100000 * 1.51 = $ 151000

    the best possible hedging strategy is Selling pound forward and receiving $155000
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