CHAPTER 8 MANAGEMENT OF TRANSACTION EXPOSURE 207
Currency Options If Boeing decides to use a currency options contract to hedge its pound payable, it
Contracts needs to buy “call” options on £5,000,000. Boeing also will have to decide on the
exercise or strike price for the call options. We assume that Boeing chooses the exer-
cise price at $1.80/£ with the premium of $0.018 per pound. The total cost of options
as of the maturity date (considering the time value of money) then can be computed
as follows:
$95,400 5 ($0.018/£) (£5,000,000) (1.06).
If the British pound appreciates against the dollar beyond $1.80/£, the strike price
of the options contract, Boeing will choose to exercise its options and purchase
£5,000,000 for $9,000,000 5 (£5,000,000) ($1.80/£). If the spot rate on the maturity
date turns out to be below the strike price, on the other hand, Boeing will let the option
expire and purchase the pound amount in the spot market. Thus, Boeing will be able to
secure £5,000,000 for a maximum of $9,095,400 (5 $9,000,000 1 $95,400), or less.
It would be useful to compare the forward hedge and options hedge. Exhibit 8.8
illustrates the dollar costs of securing £5,000,000 under the two alternative hedging
approaches for different levels of spot exchange rate on the maturity date. As can be
seen from Exhibit 8.8, options hedge would be preferable if the spot exchange rate
turns out to be less than $1.731/£ as the options hedge involves a lower dollar cost.
On the other hand, if the spot exchange rate turns out to be higher than $1.731/£, the
forward hedge would be preferable. The break-even spot exchange rate, that is, ST*,
can be computed from the following equation:
$8,750,000 5 (5,000,000) ST 1 $95,400,
where the dollar cost of securing £5,000,00 under the forward hedge is equated to
that under the options hedge. When we solve the above equation for ST , we obtain the
break-even spot exchange rate.
Dollar Costs of Securing the Pound Payable: Option versus
EXHIBIT 8.8 Forward Hedge
$9,095,400 Option hedge
$8,750,000 Forward hedge
Dollar costs ($)
$95,400
0 ST
S*T = $1.731 E = $1.80
