The reason why Cain is so concerned by the current exchange rate fluctuation is because, if the Canadian dollar does depreciate, then the $7. Million U. S. Obligation will become more costly for the firm. Cain would have to convert more Canadian dollars in order to meet the $7. Million U.
S. Obligation if the Canadian dollar is no longer worth $1. 717 U. S. 3) Please make a detailed recommendation to Cain in regard to hedging her position. Should she hedge? Why or why not? If she should hedge, which approach should she use? If you decide to use options, specify and justify the strike price. First and foremost, neither of the strategies will provide a perfect hedge.
The currencies are correct, but the date to expiration is not. This will result in some currency risk. Although these strategies will not provide a perfect hedge, it is still recommended that Cain uses one of these hedging strategies cause she will be able to buffer the currency risk.
Strategy 1 suggests buying a forward contract, and thus locks in the costs of the January $7. Million U. S. Purchase.
I see two main problems with this strategy. First, a forward contract is an obligation to buy the U. S. Currency at a future date. In the case, the largest international trader of Canadian dollars raised the forecast for the currency at U. S. $I .
08 and stated that they believe it will not depreciate past parity until the second half of the year.Therefore, entering onto a forward contract that makes you purchase the currency at a specified date is troublesome if the value of the Canadian dollar is still appreciating when the exercise date comes. Secondly, when compared to buying a call option, the forward option exposes POSIX to 27 days Of currency risk versus a call option that exposes POSIX to 21 days of currency risk. Furthermore, the firm does not have the ability to exercise prior to the expiration date with a forward contract. Therefore, I recommend buying a call option.Call options give Cain the right, UT not the obligation to buy the $7. Million U.
S. This is beneficial if the Canadian dollar continues to appreciate against the U. S. Dollar. Specifically buy the call option that can be exercised up until January 8th ATA strike price of . CANCAN. This option will have a total cost of and this is the cheapest January 8th option when compared to the other options strike and ask prices.
Therefore, buying the Jan 8th call option with a strike price of 93. 500 is the best strategy for Cain to use to minimize the currency risk that POSIX faces.