Question

# Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot...

Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot rate of British pound to be \$1.49 in a year, so it decides to avoid exchange rate risk by hedging its receivables. The spot rate of the pound is quoted at \$1.51. The strike price of put and call options are \$1.54 and \$1.53 respectively. The premium on both options is \$.03. The one-year forward rate exhibits a 2.65% premium. Assume there are no transaction costs. What is the best possible hedging strategy and how many U.S. dollars Crown Co. will receive under this strategy?

1st strategy : Selling pound forward

The spot rate of the pound is quoted at \$1.51.

The one-year forward rate exhibits a 2.65% premium.

The one-year forward rate = 1.51 ( 1+ 0.0265)

= \$ 1.55

Dollars received = 100000 * 1.55 = \$155000

2nd strategy : Buying put option

The strike price of put = \$1.54

Amount received per option = \$ 1.54 - \$ 0.03 =\$1.51

Total Dollars received = 100000* 1.51 = \$ 151000

the best possible hedging strategy is Selling pound forward and receiving \$155000

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