A U.S. company will receive payments of £1.25 million next month. It wants to protect these receipts against a drop in the value of the pound. It can use 30-day futures at a price of $1.6513 per pound or it can use a call (put) option with a strike price of $1.6612 at a premium of 1 cent (2 cents) per pound. The spot price of the pound is currently $1.6560., and the pound is expected to trade in the range of $1.6250 to $1.7010. How can the company use future or option hedge its risk? How many futures contracts will the company need to protect its receipts? How many options contracts? Diagram the company’s profit and loss associated with the option position and future position within the range of expected exchange rates. Ignore the transaction costs and margins. Show the total cash flow to the company using the options and futures contracts, as well as the unhedged position within range of expected future exchange rates. What is the break-even future spot price on the option contract? On the futures contract?

Answer rating: 100% (QA)

Payment to be received next month 125 million pounds Spot price of pound ... View the full answer