Hedging Strategies in Foreign Exchange Markets
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Questions and Answers

What is the primary benefit of hedging using the currency options market?

  • Increasing the transaction exposure
  • Reducing the option premium
  • Eliminating exchange rate risk
  • Protecting the downside while benefiting from the upside (correct)

    • What does the holder of an option have the right to do?

  • Buy/sell an asset at a market price on a pre-determined date without the obligation to do so
  • Buy/sell an asset at a pre-specified price on a pre-determined date with an obligation to do so
  • Buy/sell an asset at a pre-specified price on a pre-determined date without the obligation to do so (correct)
  • Buy/sell an asset at a market price on a pre-determined date with an obligation to do so

    • What is the cost to the hedger for using currency options?

  • The option premium (correct)
  • The forward contract rate
  • The transaction exposure
  • The exchange rate risk

    • What is the hedger's situation in the given example?

    <p>An importer requiring USD 100,000</p> Signup and view all the answers

    What is the purpose of buying a 'Put option' or 'Call option' in hedging?

    <p>To benefit from the upside but protect the downside</p> Signup and view all the answers

    When does the payment to the US Exporter need to be made?

    <p>End-September</p> Signup and view all the answers

    What is the main difference between a forward market hedge and a currency option hedge?

    <p>The forward market hedge only protects against the downside risk but not the upside risk, while the currency option hedge protects against both.</p> Signup and view all the answers

    What would be the outcome if the Mexican firm had remained unhedged and the spot rate on 21st August turned out to be USD/MXN 19.00?

    <p>It would have realized 1.90 million MXN.</p> Signup and view all the answers

    What is the key characteristic of a money market hedge?

    <p>It involves borrowing against future receivables today and exchanging the proceeds for another currency.</p> Signup and view all the answers

    Why might a money market hedge and a forward market hedge not always be perfect substitutes?

    <p>Because of market imperfections.</p> Signup and view all the answers

    What is the exchange rate risk that the US firm is exposed to in the example?

    <p>Transaction exposure to EUR.</p> Signup and view all the answers

    How does the US firm realize USD 10,912 today in the money market hedge?

    <p>By borrowing in USD and exchanging it for EUR.</p> Signup and view all the answers

    What is the purpose of entering into a forward foreign exchange contract in managing transaction exposure?

    <p>To avoid the risk of potential loss due to adverse exchange rate movements</p> Signup and view all the answers

    What is the exchange rate at which the Mexican firm will sell the US Dollar 100,000 90 days forward in the given example?

    <p>USD/MXN 18.50</p> Signup and view all the answers

    What is the amount of Mexican Pesos the Mexican firm will receive as per the forward contract?

    <p>MXN 185,000</p> Signup and view all the answers

    What is the main advantage of hedging in managing transaction exposure?

    <p>It eliminates the possibility of potential losses due to adverse exchange rate movements</p> Signup and view all the answers

    What is the term for the risk of potential loss due to adverse movement in the exchange rate between the time the foreign exchange exposure is created and the time the payment is received?

    <p>Transaction Exposure</p> Signup and view all the answers

    What is the consequence of hedging in terms of potential gains?

    <p>It negates the possibility of potential gains</p> Signup and view all the answers

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