Question

You are the VP and Treasurer of a sizeable multinational firm. Assume that your general approach to hedging the Company’s transaction risks is to do nothing. However you do, from time to time, like to play the market a little with the firm’s surplus cash and you frequently speculate on anticipated moves in currencies. One of those is the British Pound (GBP) and, based on your careful analysis, you truly expect the GBP to strengthen against the US Dollar in the next six months.

a. What investment (or set of investments) could be used to take advantage of this speculative expectation?

b. What is the degree of financial risk associated with the investment (or investments) you identified in part ‘a.’ just above in the event you are wrong about the expected trend in the GBP/USD?

Answer 1

If one expects the US Dollar (Since British pound is appreciating against US Dollar) to depreciate one may sell call options on pounds.

RATIONALE- Selling call options when you expect that US Dollar will fall, will result in call option expiring without any payoff from your side. You will earn option premium. However if it rises you do not have to jeopardize firm operations since you have alreaady locked in the price.

Selling forwards/futures will entail obligation from your side to buy the US Dollar even if you do not need it. It will also costs much more than just options.

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