Question: Question (Hedging with Options - 10 marks) Farmer, Inc is a US company with a Euro 5 million receivable due in three months. The current

Question (Hedging with Options - 10 marks)

Farmer, Inc is a US company with a Euro 5 million receivable due in three months. The current spot rate is US$1.1155/Euro. Three month call options and put options on Euros with a strike price of $1.1200 are available on PHLX with a premium of US$0.02 per Euro. The contract size is 10,000 Euros.

Required

(a) What options position should Farmer take in order to hedge its currency exposure in the options market? Explain. (2 marks)

(b) Using your answer to part (a), calculate the total hedged value of the receivable if in three months' time:

(i) The Euro has strengthened against the dollar to $1.1310/Euro. (3 marks)

(ii) The Euro has weakened against the dollar to $1.1085? (3 marks)

(c) What are the advantages and disadvantages to Farmer of hedging the currency exposure in the options market rather than the forward market?

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