1. StudsPlanet
Leading Education consultant in India
www.StudsPlanet.com

2. Hedging with ForeignHedging with Foreign
Currency OptionsCurrency Options
International Finance – GSM 658
Eli Waite

3. Currency OptionsCurrency Options
“A foreign currency option contract is a
financial instrument that gives the holder the
right but not the obligation to sell or buy
currencies at a set price either on a specific
date or before some expiration date.”
(The Theory and Practice of International Financial Management, Click and Coval, 2002)

4. What are they good for?What are they good for?
 Hedging
◦ Potential transactions
◦ Transactions that depend on something else
◦ Uncertain demand
 “Quantity Risk”
 Limit downside risk, but reap most of the
upside.

5. Details, Details, DetailsDetails, Details, Details
Call Options
◦ The right to buy a currency at the strike price
◦ Used to hedge foreign currency outflows
Put Options
◦ The right to sell a currency at the strike price
◦ Used to hedge foreign currency inflows

6. Details, Details, Details cont.Details, Details, Details cont.
 Contract Size = 10,000 foreign currency
units (1,000,000 Yen) (Source:
http://www.phlx.com/products/wco_faq.html#3)
 Expiration, the third Friday of the expiration
month. (Source: http://www.phlx.com/products/product_specs.html)
 American Options – Can be exercised
ANYTIME before maturity.
 European Options – Can ONLY be exercised
at maturity.

7. How it works – Put Option
Source:
(http://upload.wikime
dia.org/wikipedia/en/
d/d1/PutOption.png)

8. How it works – Call Option
Source:
(http://upload.wikime
dia.org/wikipedia/en/
7/7f/CallOption.png)

9. Questions to askQuestions to ask
Strike Price?
Maturity?
American or European?

10. QuotesQuotes
Philadelphia Exchange
◦ http://www.phlx.com/

11. Example OneExample One
Pace Co, a cheese and wine store in
Salem, OR has placed a €20,000 bid for a
very rare wine from France on March 18.
The results of the auction will not be
known until May. The management team
at Pace Co is worried that the Euro will
continue its recent appreciation and would
like to lock in an exchange rate so that
the cost of the auction does not get out of
hand without having to commit to a
contract. What should they do?

12. Example TwoExample Two
Pace Industrials based in Salem, OR has
placed a bid with the Australian
government to be one of the sub-
contractors to build a bridge to Tasmania
for AU$2,000,000. The winning bid will be
selected in June (they will be paid at that
time). The management team is
concerned that the Australian dollar may
depreciate and wants to lock in an
exchange rate incase they receive the
contract. What should they do?

13. Questions?Questions?