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 an Italian firm to hedge a £100,000 payable,
A)buy 10 call options on the pound with a strike in euro.
B)buy 8 put options on the euro with a strike in pounds.
C)both a and b will work.
D)simultaneously use strategies a and b
E)none of the above

Question

Quizplus · Accepted Answer

Both strategies will work because they both create a synthetic forward contract with a forward rate of £1.00 = €1.25.

Suppose That the Exchange Rate Is €1