Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts)are available on the Philadelphia exchange in units of €10,000 with strike prices of $1.60/€1.00.Options (calls and puts)are available on the Philadelphia exchange in units of £10,000 with strike prices of $2.00/£1.00.For a U.S.firm to hedge a €100,000 payable,
A)buy 10 call options on the euro with a strike in dollars.
B)buy 8 put options on the pound with a strike in dollars.
C)sell 10 call options on the euro with a strike in dollars.
D)sell 8 put options on the pound with a strike in dollars.

Question

Quizplus · Accepted Answer

BTo hedge a €100,000 payable, the U.S. firm needs to protect against the euro becoming more expensive in dollar terms. Buying call options on the euro (A) allows the firm to buy euros at a predetermined rate, thus hedging against the euro's appreciation. Since options are in units of €10,000, 10 call options are needed for €100,000. Similarly, buying put options on the pound (B) can also hedge the risk, as the firm can convert euros to pounds and then to dollars. Given the exchange rate of €1.25 = £1.00, €100,000 is equivalent to £80,000, requiring 8 put options on the pound.

Suppose That the Exchange Rate Is €1