Question

1.Briefly explain how a U.S. company that exports to Europe can hedge against exchange rate risk

2.What is the advantage of using options instead of forwarding contracts when hedging against exchange-rate risk?

3.What is the advantage of using forward contracts instead of options to hedge against exchange-rate risk?

Answer 1

ANSWER-

1. Companies that have exposure to foreign markets can often hedge their risk with currency swap forward contracts. Many funds and ETFs also hedge currency risk using forward contracts. A currency forward contract, or currency forward, allows the purchaser to lock in the price they pay for a currency.

2.The main advantage of using options contracts for hedging is that the hedger can decide whether to exercise options upon observing the realized future exchange rate. Options thus provide a hedge against ex post regret that forward hedger might have to suffer.

3.the advantage of forward contracts is that they can be customized to specific amounts and maturities, a major drawback is that they are not readily accessible to individual investors. An alternative way to hedge currency risk is to construct a synthetic forward contract using the money market hedge