Question

If GM does deviate from its formal policy for its CAD exposure, how should GM think about whether to use forwards or options for the deviation from the policy?

Answer 1

If GM does deviate from its formal policy for its CAD exposure, then there are 2 options left:

1. Use forward exchange contracts- GM will be required to fulfill an obligation of forward contracts irrespective of the no. of contracts that will be required during maturity. This will restrict the GM from exploiting the downside favourable movement in exchange rates and GM will mandatorily have to fulfil the obligation regarding the contract

2. Use forward contract options- GM will get the advantage of exploiting gains from favourable movements in exchange rates as there are no obligations to execute the transaction at maturity, however there is an obligation to pay premium amounts upfront.

Taking the above analytical pointers into consideration, GM should take a decision as to whether to opt for forwards or options.