Question

1. Your Uncle’s export business has been booming recently and he remarked how his earnings vary according to the exchange rate (which has been particularly volatile in recent months). He explained that this uncertainty hinders his capital budget planning, especially as competition was fierce and margins were low. You explained to him that this uncertainty may be mitigated via derivative, specifically, forwards and options. He liked the idea of options and didn’t understand why any company would choose a forward over an option.

Briefly provide one or more reasons why a forward may be preferable to an option.

Answer 1

He should opt for forward over and option because-

1.forward contracts are highly customised in nature and they can be customised according to the needs of the participants while option contracts are standardized contracts and they are not customised according to the needs of participants.

2.forwards are obligatory in nature while options are never obligatory in nature. options will just give you a right to exercise, while one has to exercise forward contract.