Suppose that you have written a call option on €10,000 with a strike price in dollars.Suppose further that the hedge ratio is ¹/₂.Which of the following would be an appropriate hedge for a short position in this call option? A)Buy €5,000 today at today's spot exchange rate. B)Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today . C)Buy the present value of €5,000 discounted at i€ for the maturity of the option. D)Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today or buy the present value of €5,000 discounted at i€ for the maturity of the option.

Question

Quizplus · Accepted Answer

The appropriate hedge for a short position in this call option would be to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today, or buy the present value of €5,000 discounted at i€ for the maturity of the option. This is because the hedge ratio suggests that the hedge should involve both euro and dollars, and the options contract involves a fixed euro amount. Option D allows for the purchase of euros at a fixed exchange rate in the future, which mitigates the risk of exchange rate fluctuations affecting the value of the option. Additionally, the present value of €5,000 discounted at i€ for the maturity of the option can also serve as a hedge as it involves the purchase of euros at a fixed rate, even though it is done in the present.

Suppose That You Have Written a Call Option on €10,000