Question

Francis currently lives in Paris. He is traveling to Las Vegas, USA next month (Cardi B has a residency there). He plans to take €50,000 with him. However, he is worried about a movement in the $/€ exchange rate. He believes the dollar will strengthen against the euro. What should he do if he wants to protect himself against a move in the exchange rate?

Multiple Choice

• Sell euros forward with a maturity next month

• Sell dollars forward with a maturity next month

• Buy a call option on euros with a maturity next month

• Sell a put option on euros with a maturity next month

• Buy euros forward with a maturity next month

Answer 1

Solution : -

The correct answer is (A)

That is Sell Euros forward with a maturity next month

Here we see Francis has translation exposure in the transaction. Required Euros 50000 after a month which convert into dollars after 1 month. There is a risk of dollars increasing in value or euros falling in value.

To hedge the above risk Francis has to sell euros forward with a maturity next month.

If the dollars increase in value the forward agreement will lock in a exchange rate due to which risk is minimized.