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Finance 407: Multinational Financial Management
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Topic #10: Currency options and hedging
L. Gattis
The Pennsylvania State University
Poll
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What is your profit if you take a short position in 5 euro futures contracts at a price of $1.2501 and the euro is selling for $1.2651 at maturity? Each contract was for 100,000.
A. $7,500 B. $7,500 C. $1,500, D. $1,500
E. None of the above
Learning Objectives
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Learning Objectives
Students can use compute the costs, payoff and profits of options and understand how options are used to hedge fx positions
Foreign Currency Options
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A foreign currency option is a contract giving the option purchaser
the right, but not the obligation,
to buy (Call Option) or sell (Put Option) a given amount of foreign exchange at a fixed price per unit
for a specified time period (until the expiration date).
Exercise Type:
American Option; buyer has the right to exercise the option at any time between the date of writing and the expiration
European Option: can be exercised only on the expiration date
The option buyer pays the Seller (a.k.a. writer or
grantor) a premium for the option
Price Elements of an Option
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Every option has three different price elements:
1. The exercise or strike price, which is the exchange rate at which foreign currency can be purchased (call) or sold (put).
2. The premium, cost, price, or value of the option itself (paid in advance by the buyer to the seller).
3. The underlying or actual spot exchange rate in the market.
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