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 receivable,
A)buy 10 call options on the euro with a strike in dollars.
B)buy 10 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

To hedge a €100,000 receivable, the firm needs to protect itself against a possible depreciation of the euro against the dollar, which would result in a loss for the firm. Therefore, the best choice is to buy put options on the pound with a strike in dollars, as a depreciation of the euro would typically result in an appreciation of the pound. By doing so, the firm would have the right to sell pounds at a fixed price (strike price), which would increase in value if the pound appreciates. The other options, such as buying call options on the euro or selling call options on the euro, do not offer the same level of protection against a possible depreciation of the euro. The option of selling put options on the pound would also be a viable strategy, but the number of contracts needed would depend on the specific contract size of the pound options, which is not provided in the question.

Suppose That the Exchange Rate Is €1