Suppose I own a French winery and that I am selling wine to theUS in 90 days for a price of $ 100,000. The current spot price is $1.3 / â¬. We are going to use the option market to hedge againstunfavorable exchange rate movements.
a. Considering this transaction only, what do we mean by'unfavorable' exchange rate movements?
b. Suppose it costs me ⬠70,000 to produce and transport thewine, if the exchange rate in 90 days is the same as the currentspot ($1.3/â¬), what is my profit in terms of euros? Suppose thatthere are options available that give me the option to exchange $for ⬠at an exchange rate of $1.4 per â¬. Suppose these optionscollectively cost you ⬠5000. We are going to consider two separatescenarios: Scenario #1: In 90 days, the spot exchange rate is $1.2/â¬. Scenario #2: In 90 days, the spot exchange rate is $ 1.5/â¬.Reminder: The options give you the right, not the obligation toexchange your $100,000 at $1.4 per â¬
. c. Given Scenario #1, what is your total profit / loss fromselling the wine?
d. Given Scenario #2, what is your profit / loss from sellingthe wine?
e. Compare your answer in d) to your profit / loss if you,instead of hedging with options, went 'naked' as in not hedging atall (taking you chances in the spot market). Was it better to hedgeor go naked? Assume Scenario #2.
f. How would your answer change in e) above if the spot rate was1.6 $/⬠(90 days from now) instead of the $ 1.5/⬠as in scenario#2.
Suppose I own a French winery and that I am selling wine to theUS in 90 days for a price of $ 100,000. The current spot price is $1.3 / â¬. We are going to use the option market to hedge againstunfavorable exchange rate movements.
a. Considering this transaction only, what do we mean by'unfavorable' exchange rate movements?
b. Suppose it costs me ⬠70,000 to produce and transport thewine, if the exchange rate in 90 days is the same as the currentspot ($1.3/â¬), what is my profit in terms of euros? Suppose thatthere are options available that give me the option to exchange $for ⬠at an exchange rate of $1.4 per â¬. Suppose these optionscollectively cost you ⬠5000. We are going to consider two separatescenarios: Scenario #1: In 90 days, the spot exchange rate is $1.2/â¬. Scenario #2: In 90 days, the spot exchange rate is $ 1.5/â¬.Reminder: The options give you the right, not the obligation toexchange your $100,000 at $1.4 per â¬
. c. Given Scenario #1, what is your total profit / loss fromselling the wine?
d. Given Scenario #2, what is your profit / loss from sellingthe wine?
e. Compare your answer in d) to your profit / loss if you,instead of hedging with options, went 'naked' as in not hedging atall (taking you chances in the spot market). Was it better to hedgeor go naked? Assume Scenario #2.
f. How would your answer change in e) above if the spot rate was1.6 $/⬠(90 days from now) instead of the $ 1.5/⬠as in scenario#2.
