abhishreshthaa
Abhijeet S
Hedging a receivable with a put option
A German chemical firm has supplied goods worth Pound 26 million to a British customer. The payment is due in two months. The current DEM/GBP spot rate is 2.8356 and two month forward rate is 2.8050. An American put option on sterling with 3 month maturity and strike price of DEM 2.8050 is available in the inter bank market with a premium of DEM 0.03 per sterling.
The firm purchases a put option on pound 26 million .The premium paid is DEM (0.03 * 26000000) = DEM 780000. There are no other costs.
Effectively the firm has put a floor on the value of its receivable at approximately DEM 2.7750 per sterling (= 2.8050-0.03). Again two e.g. are considered:
1. The pound sterling depreciates to DEM 2.7550 .The firm exercises its put option and delivers pound 26 million to the bank at the price of 2.8050. The effective rate is 2.7750. It would have been better off with a forward contract.
Sterling appreciates to DEM 2.8575. The option has no secondary market and the firm allows it to lapse. It sells the receivable in the spot market. Net of the premium paid, it obtains an effective rate of 2.8275, which is better than forward rate.
If the interest forgone on premium payment is accounted for, the superiority of the option over the forward contract will be slightly reduced.
A German chemical firm has supplied goods worth Pound 26 million to a British customer. The payment is due in two months. The current DEM/GBP spot rate is 2.8356 and two month forward rate is 2.8050. An American put option on sterling with 3 month maturity and strike price of DEM 2.8050 is available in the inter bank market with a premium of DEM 0.03 per sterling.
The firm purchases a put option on pound 26 million .The premium paid is DEM (0.03 * 26000000) = DEM 780000. There are no other costs.
Effectively the firm has put a floor on the value of its receivable at approximately DEM 2.7750 per sterling (= 2.8050-0.03). Again two e.g. are considered:
1. The pound sterling depreciates to DEM 2.7550 .The firm exercises its put option and delivers pound 26 million to the bank at the price of 2.8050. The effective rate is 2.7750. It would have been better off with a forward contract.
Sterling appreciates to DEM 2.8575. The option has no secondary market and the firm allows it to lapse. It sells the receivable in the spot market. Net of the premium paid, it obtains an effective rate of 2.8275, which is better than forward rate.
If the interest forgone on premium payment is accounted for, the superiority of the option over the forward contract will be slightly reduced.