Assume that today is April 7, and you must advise a client on the costs and benefits of hedging a transaction with options. Your client is a US exporting firm and is scheduled to receive a payment of E5,090.090 on September 9. i.e., 155 days in the future. Assume that your client can borrow and lend at a 12% per annum US interest rate, and 15% per annum Euro interest rate. Also consider options with a September 9 maturity and a strike price of 150 c/: the cost of the call option is 3.10 c/E, and the cost of the put option is 2.80 4/E. 

(a) If the client wants to conduct option hedge, which of the two options is the appropriate option to hedge the transaction risk? Find the total dollar cost of that option today. 

(b) If the client does option hedge, what is the minimum net revenue in USD your client will receive in September? Remember to take account of the opportunity cost of doing the option hedge.

(c) Determine the value of the spot rate ($/C) in September that would make your client indifferent ex post to having done the option transaction or a forward hedge. The forward rate for delivery on September 9 is $1.43/ E.

Answer rating: 100% (QA)

a To determine the appropriate option to hedge the transaction risk we need to consider the potential scenarios that could occur by the September 9th payment date If the Euro appreciates against the U... View the full answer