US firm submitted a fixed bid for a Euro multimillion project in Ukraine. The contract will be awarded in 12 months and the company knows there will be no advance payments. The company
A) should pay the premium for a 3 months put currency option to hedge the quotation exposure.
B) should write 3 months put currency option, receive the premium and roll it forward.
C) should buy 12 months put option and limit the loss to the premium amount if the bid gets rejected.
D) should get 1 year Euro denominated loan equal to the bid amount.

Question

Quizplus · Accepted Answer

The best option for the company would be to buy a 12-month put option, which will limit the loss to the premium amount if the bid gets rejected. This would provide protection against unfavorable fluctuations in the exchange rate between the US dollar and Euro. Since there will be no advance payments and the contract will be awarded in 12 months, the company does not need to hedge its quotation exposure for the first 9 months. A 3-month put option would not provide sufficient protection, and writing a put option would expose the company to unlimited losses. Getting a Euro-denominated loan would also expose the company to exchange rate risk and interest rate risk, and the company would also need to manage the currency risk associated with repaying the loan.

US Firm Submitted a Fixed Bid for a Euro Multimillion