Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts)are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00.Options (calls and puts)are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00.For a U.K.firm to hedge a €100,000 payable,
A)buy 10 call options on the euro with a strike in pounds sterling.
B)buy 8 put options on the pound with a strike in euro.
C)sell 10 call options on the euro with a strike in pounds sterling.
D)buy 10 call options on the euro with a strike in pounds sterling and buy 8 put options on the pound with a strike in euro.

Question

Quizplus · Accepted Answer

The correct answer is D because the firm is payable in euros, so it needs to buy call options on the euro to hedge against a rise in the euro's value. The firm also needs to buy put options on the pound to hedge against a fall in the pound's value.

Suppose That the Exchange Rate Is €1