Question

Explain why a company would prefer a foreign currency option over a forward contract in hedging a foreign currency firm commitment, and why a company would prefer a forward contract over an option in hedging a foreign currency asset or liability.

Answer 1

A foreign curreny option provides an option to excercise but the firm is not obligated to exercise the option so companies prefer a foreign currency firm commitment as the rates keep on fluctuating and it provides an option the compnay with an option to have exposure of upside potenial with a less cost where as locking the downside.

With foreign currency forward contract company is obligated to deliver one currency in exchange for another at a specified future date allowing the company to lock the value of assets and liability.