A US-based investor buys from you a quanto option in which the payoffs from a euro-denominated call on a German company are converted back into US dollars at the fixed rate of $1.25/€.To hedge this transaction
A)You must hedge both exchange rate and equity price risk.
B)You must hedge equity price risk but there is no exchange rate risk.
C)You must hedge exchange rate risk but there is no equity price risk.
D)There is nothing you need to do.

Question

Quizplus · Accepted Answer

The investor is exposed to both equity price risk (the performance of the German company) and exchange rate risk (fluctuations in the value of the euro versus the US dollar), so both risks need to be hedged to manage the overall risk of the transaction.

A US-Based Investor Buys from You a Quanto Option in Which