Blades Inc has to make the payment of 12.5 million yen after 2 months. It has two options to hedge its payables. The first option is call option with exercise price of $0.00756 and premium of $0.000152 another is call option with an exercise price of $0.00792 and option premium of $0.0001134. If Blades hedges its payables using first call option the amount of premium payable by Blades will be $1890 and on exercise of option amount payable for purchase of yen will be $94,500. Thus the total amount payable under first option being $96,390. Similarly if Blades uses second option to hedge its payables the option premium payable will be $1417.50 and on exercise of option the amount that will be payable is $99,000. Thus total amount to be paid will be $100,417.50. Since the amount payable for hedging the payables is more under second option therefore Blades shall choose call option first with exercise price of $0.00756. Though the premium in this option is more but the amount that will be required to be paid on exercise of this option is less as compared to second option. (Fonseca, 2012)
The trade off for Blades in choosing first option over second will be the difference in the amount payable. It will be calculated as follows:
If option is exercised
Trade off = $100,417.5 – $ 96,390
= $4027.5 Profit
If option is not exercised
Trade off = $1417.5 – $1890
= $ 472.5 loss
If Blades allows its yen position to be unheeded then in case if yen appreciates after two months then the amount payable by Blades for acquiring yen to make the payment will be excessive as compared to the amount that will be payable by yen if option is exercised. However if yen depreciates the company can be better off with the amount of option premium that would have been paid if option was purchased and payables were hedged.
The exercise price of option is 5 % above the spot rate with option premium of 1.5% of exercise price. Thus it can be expected that the yen will appreciate by 5% in future at delivery date. However the future price is less than the spot rate.
If the payables will be hedged using options the total amount payable will be $96390, under futures hedging the total amount payable after 2 months will be $ 86400 and if remains unheeded the total amount assumed to be payable will be $90000. (It is assumed that the spot rate will remain the same after two months in absence of information). Thus the optimal choice will be to hedge the payables using futures contract since the amount payable for yen is least.
The choice of optimal hedging strategy will not definitely turn out to be the lower cost alternative because the spot rate on the delivery date cannot be estimated. The trade off the company faces will depend completely on the spot rate on the delivery date. (Wang, 2015)
If the standard deviation of yen of $0.0005 is applied to the spot rate the future spot rate which cannot be higher than the two standard deviations above the spot rate will be maximum possible up to $0.0082. In this case also the optimum hedging strategy will be hedging through futures contract since it will be the lower cost alternative.
|Total amount payable||96390||86400||102500|
IN this scenario we have been given information regarding with $ and Thai Baht in which fowling information is given
Bid rate: – It Is the rate at which bank will buy Thai baht from the market
Ask rate: – it is the rate at which bank will sell the Thai baht in the market.
Holt has obtained spot rate quotation from two various banks and now he wants to make arbitrage profit.
He has $ 100000 with the help of which he could buy $100 000/0.224= 4464285.7 Thai baths
Now the same could be sold to other bank 4464285.7*0.228 = $101785.17
Arbitrage profit: – $ 100000-$101785.17= $1785.
In this question it is given that Hold can withdraw $100000 from the bank in order to generate arbitrage profit
Holt can purchase Japanese yen with the help of dollars 100000=$100000*.0085=850 yen
Now we can also consider that $ can be converted into Thai baths =$100 000/0.224= 4464285.7 Thai baths
And Thai baths could be sold for the consideration of yen in market.-
Now we can convert this amount into $=12008928.5*.0086=103276.78
Forward Rate: – spot rate *(1+interest rate of the oversee country)/1+ interest rate of domestic country
Profit generated with the help of dissimilarities in forward rate
Arbitrage profit is the amount which can be generated with the help of creating value by exchange of two currencies in the market. The direction in which the value of a currency is heading can cause cash to flow into or out of that currency. A currency that is appreciating can cause money to flow into its country’s assets as investors and Fore traders want to benefit from buying or taking “long” positions on the currency as the currency’s price rises. Angel investors or incubators are the most persons who take the advantages of this Mid-point. Once this result is identified pool of people take advantage of this in order to overcome such difficulties. The equilibrium point is also called no profit no loss point.Forex Market Deciphered. (Kibzun, 2015)
- Fonseca, R.J. & Rustem, B. 2012, “Robust hedging strategies”, Computers & Operations Research, 39, no. 11, pp. 2528-2536.
- Guo, H. 2016, “Risk efficiency of hedging strategy in China financial market”, Perspectives in Science, 7, pp. 19-23.
- Kibzun, A.I. & Sobol’, V.R. 2015, “The modified sequential hedging strategy: Hedger’s loss distribution”, Automation and Remote Control, 76, no. 11, pp. 1931-1944.
- Wang, X., Zhao, Z. & Fang, X. 2015, “Option pricing and portfolio hedging under the mixed hedging strategy”,Physica A: Statistical Mechanics and its Applications, 424, pp. 194-206.Order Now