Mini Case 2
MiniCase 2
1. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0.00756 or the call option with the exercise price of $0.00792? Describe the tradeoff.
The corporation needs to purchase supplies with foreign currency. To hedge against the possible appreciation of the foreign currency's value, the corporation can purchase a call option. Both options have to pay a premium for the option. The purchase price or exercise price of option A is $0.00756 plus a premium paid on this respective option of $.0001512 resulting in a total cost of $.0077112 per yen. The purchase or exercise price of option B is $0.00792 plus a premium paid of $.0001134 resulting in a total cost of $.0080334 per yen. Option A is the better option, relatively. Option B has a higher exercise price, though its exercise price is lower, the overall result is a higher amount paid for yen if the option is exercised. If the option is likely not to be exercised, option B is the best choice. The corporation would only have to pay the premium price and not the exercise price. In this case, option B's premium price is lower. The trade off is between a lower exercise price, higher premium price, option A, that better hedges against the yen if it were to appreciate in value (exercising the option) and a higher exercise price, lower priced premium that reduces cost if the hedge does not appreciate in value (the option is not exercised).
2.Should Blades allow its yen position to be unhedged? Describe the tradeoff.
The case stated that “the futures price on yen has historically exhibited a slight discount from the existing spot rate”. In this case, the exercise price of the option may be higher relative to the future spot rate encouraging the investor to let the option expire. If the option were to expire the corporation would still have to pay the premium and any other non-exercise costs. An unhedged position might be the best position
1. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0.00756 or the call option with the exercise price of $0.00792? Describe the tradeoff.
The corporation needs to purchase supplies with foreign currency. To hedge against the possible appreciation of the foreign currency's value, the corporation can purchase a call option. Both options have to pay a premium for the option. The purchase price or exercise price of option A is $0.00756 plus a premium paid on this respective option of $.0001512 resulting in a total cost of $.0077112 per yen. The purchase or exercise price of option B is $0.00792 plus a premium paid of $.0001134 resulting in a total cost of $.0080334 per yen. Option A is the better option, relatively. Option B has a higher exercise price, though its exercise price is lower, the overall result is a higher amount paid for yen if the option is exercised. If the option is likely not to be exercised, option B is the best choice. The corporation would only have to pay the premium price and not the exercise price. In this case, option B's premium price is lower. The trade off is between a lower exercise price, higher premium price, option A, that better hedges against the yen if it were to appreciate in value (exercising the option) and a higher exercise price, lower priced premium that reduces cost if the hedge does not appreciate in value (the option is not exercised).
2.Should Blades allow its yen position to be unhedged? Describe the tradeoff.
The case stated that “the futures price on yen has historically exhibited a slight discount from the existing spot rate”. In this case, the exercise price of the option may be higher relative to the future spot rate encouraging the investor to let the option expire. If the option were to expire the corporation would still have to pay the premium and any other non-exercise costs. An unhedged position might be the best position