Question

A US-based company will receive 25 million euros (EUR) in March for goods that it exported to Europe. Suppose that on December 13, the futures price for March expiry is $/E 1.0328 and each contract is standardized for delivery of 125,000 euros. Suppose also that the company can buy a put option with a strike price of $/E 1.03, which costs $1,056.25 per contract, and requires the delivery of 62,500 euros per contract. If the exchange rate is $0.9928/euro in March, which strategy yields the higher cash flows for the company and by how much?

Futures by $492,500

Futures by $556,500

Put by $365,500

Put by $759,500

Please show step by step solving problem.

Answer 1

Since the company will be receiving 25 mn Euro it is long on Euro and Short on USD.

• Strategy 1 : Therefore to hedge it has to short euro futures at 1.0328. Number of contracts shorted:

25,000,000/125,000= 200

             On March when exchange rate settles at 0.9928 then profit:

                  =(1.0328-0.9928)*200*125,000= 1,000,000

• Strategy 2: Buying a put option on Euro. Number of put options required:

25,000,000/62500=400

Cost of buying 400 contracts : 400* 1056.25= 422,500

             On March when exchange rate settles at 0.9928 then profit:

(1.03-0.9928)*400*62500 -422500= 507,500

Hence, future strategy yields higher profit by : 1,000,000-507,500= $ 492,500