Question

MTB Ltd. is an Australian exporter, sold a special raw material to a manufacturing
company based in Switzerland. The sale is denominated in Swiss francs with
payment due upon delivery in three (3) months, amount is CHF 200,000.
Required:
a. How can MTB Pty Ltd. use the currency options to hedge foreign-currency
exposures resulting from international transactions?
b. Describe the key benefit and the key drawback of using currency options
rather than future and forwards contracts?

Question 2 (4 marks) MTB Ltd. is an Australian exporter, sold a special raw material to a manufacturing company based in Switzerland. The sale is denominated in Swiss francs with payment due upon delivery in three (3) months, amount is CHF 200,000. Required: a. How can MTB Pty Ltd. use the currency options to hedge foreign-currency exposures resulting from international transactions? (2 marks) b. Describe the key benefit and the key drawback of using currency options rather than future and forwards contracts? (2 marks)

Answer 1

a]	As it is a sale denominated in CHF, the MTB can
	buy a put option to sell CHF 200,000 after 90 days;
	that is the time when the sale value in CHF would
	be received.
	The put option would specify the exchange rate;
	that is the number of AUD receivable per CHF
	after 90 days. This rate is fixed.
	But, there would be a cost for this contract [right
	to sell] which is called the 'option premium', which
	is payable upfront.
	Being an option, on the date of expiry of the option,
	MTB can compare the option price with the then
	spot price and
	*can exercise the option if, the spot price is less
	than the option price, or
	*can allow the option to lapse if, the spot price is
	more than the option price. In such a case more
	AUD can be realized by selling the CHF received in
	the then spot market rate.
b]	Key benefit:
	The option contract gives a right to sell the CHF but
	not an obligation to do so. If the MTB wants it can
	let the option lapse and thn sell the CHF received
	in the spot market.
	Both forwards and futures need to be settled.
	Key drawback.
	The option premium becomes a sunk cost and is
	irrelevant for decision making at the time of expiry
	of the option.