Question

3) An importer of Swiss watches has an account payable of CHF750,000 due in 90 days. The following data is available: Rates and prices in US cents/CHF. Spot rate: 71.42 cents/CHF 90-day forward rate: 71.14 cents/CHF US dollar 90-day interest rate: 3.75% per year Swiss franc 90-day interest rate: 5.33% per year Option Data in cents/CHF Strike 70 Call 2.55 1.55 Put 1.42 2.40 a) Assess the USD cost to the importer in 90 days if it uses a call option to hedge its CHF750,000 account payable. Use the call with a strike price of 72 cents/CHF and include the option call premium in the cost. b) What will be the cost of the payable in 90 days if a forward contract is used? c) By how much must the CHF weaken relative to the USD, from 71.42 cents/CHF before the call option provides a lower cost than the forward hedge?

Answer 1

Ans.a) Amount Payable by importer = CHF 750000

Importer is having a risk of CHF appreciating against US Cents, to hedge the risk:

1 sell the call option Strike 72 @ 1.55 for 90 days contract.

Or

92 Buy a put option strike of 72 @ 2.40 for 90 days contract.

If he is taking call option then for hedging the calculation is as follow:

Amt payable CHF 750000, Lot size for the currency pair USD/CHF = 1000

No. of lots required for hedging = 750000/1000 = 750 Lots.

Since he is selling a call option, being a seller he will receive the premium = 1.55 *750*1000 = 1162500

2) Hedging the position using forward contract:

as discussed in point (a) He need to sell 750 lots of forward contract

Given 90 days Forward Rate = 71.14 cents/CHF

Importer need to sell forward contract for that amnt need to be paid = 750*71.14*1000 = 53355000

c) Given the interest rate for two currencies USD 3.75% and CHF 5.33% per annum

To Calculate forward price for 90 days we need to use Interest rate parity formula: $attachment.ashx?id=RgAAAAD5mxVnaIjqQ55lp$

Where

F = Forward rate

S = Spot rate

Rqc = Interest rate of Quote Currency (CHF)

Bqc = Interest rate of base Currency( USD)

Term = 90 days

F = 71.42* ((1+0.0375*3/4)/(1+0.0533*3/4))=70.61

The CHF can weaken to 71.42-70.61=0.81 cents