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FX Risk Management Transaction Exposure Overview The three major foreign exchange exposures Foreign exchange transaction exposure Pros and cons of hedging foreign exchange transaction exposure Alternatives of managing significant transaction exposure

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fx risk management transaction exposure
FX Risk ManagementTransaction Exposure
  • Overview
    • The three major foreign exchange exposures
    • Foreign exchange transaction exposure
    • Pros and cons of hedging foreign exchange transaction exposure
    • Alternatives of managing significant transaction exposure
    • Practices and concerns of foreign exchange risk management
foreign exchange exposure
Foreign Exchange Exposure
  • Types of foreign exchange exposure
    • Transaction Exposure – measures changes in the value of outstanding financial obligations due to exchange rate changes
    • Operating Exposure – also called economic exposure, measures the change in the present value of the firm resulting from any change in expected future operating cash flows caused by an unexpected change in exchange rates
    • Translation Exposure – also called accounting exposure, is the changes in owner’s equity because of the need to “translate” financial statements of foreign subsidiaries into a single reporting currency for consolidated financial statements
    • Tax Exposure – as a general rule only realized foreign losses are deductible for purposes of calculating income taxes
foreign exchange exposure3

Moment in time when exchange rate changes

Operating exposure

Accounting exposure

Change in expected future cash flows

arising from an unexpected change in

exchange rates

Changes in reported owners’ equity

in consolidated financial statements

caused by a change in exchange rates

Transaction exposure

Impact of settling outstanding obligations entered into before change

in exchange rates but to be settled after change in exchange rates


Foreign Exchange Exposure
why hedge the pros cons
Why Hedge - the Pros & Cons
  • Opponents of hedging give the following reasons:
    • Shareholders are more capable of diversifying risk than the management of a firm
    • Currency risk management does not increase the expected cash flows of a firm
    • Management often conducts hedging activities that benefit management at the expense of shareholders
    • Managers cannot outguess the market
    • Management’s motivation to reduce variability is sometimes driven by accounting reasons
    • Efficient market theorists believe that investors can see through the “accounting veil” and therefore have already factored the foreign exchange effect into a firm’s market valuation
why hedge the pros cons5
Why Hedge - the Pros & Cons
  • Proponents of hedging give the following reasons:
    • Reduction in the risk of future cash flows improves the planning capability of the firm
    • Reduction of risk in future cash flows reduces the likelihood that the firm’s cash flows will fall below a necessary minimum – avoiding bankruptcy costs
    • Management has a comparative advantage over the individual investor in knowing the actual currency risk of the firm
    • Markets are usually in disequilibirum because of structural and institutional imperfections
    • Reduction in variability of income reduces a firm’s overall tax burden

Why Hedge - the Pros & Cons



Net Cash Flow (NCF)


Expected Value, E(V)

Hedging reduces the variability of expected cash flows about the mean of the distribution.

This reduction of distribution variance is a reduction of risk, but who benefits from it.

measurement of transaction exposure
Measurement of Transaction Exposure
  • Transaction exposure measures gains or losses that arise from the settlement of existing financial obligations, namely
    • Purchasing or selling on credit goods or services when prices are stated in foreign currencies
    • Borrowing or lending funds when repayment is to be made in a foreign currency
    • Being a party to an unperformed forward contract and
    • Otherwise acquiring assets or incurring liabilities denominated in foreign currencies
purchasing or selling on open account
Purchasing or Selling on Open Account
  • Suppose Trident Corporation sells merchandise on open account to a Belgian buyer for €1,800,000 payable in 60 days
  • Further assume that the spot rate is $0.9000/€ and Trident expects to exchange the euros for €1,800,000 x $0.9000/€ = $1,620,000 when payment is received (assuming no change in exchange rate)
    • Transaction exposure arises because of the risk that Trident will receive something other than $1,620,000 expected
    • If the euro weakens to $0.8500/€, then Trident will receive $1,530,000
    • If the euro strengthens to $0.9600/€, then Trident will receive $1,728,000
purchasing or selling on open account9
Purchasing or Selling on Open Account
  • Trident might have avoided transaction exposure by invoicing the Belgian buyer in US dollars, but this might have caused Trident not being able to book the sale
  • Even if the Belgian buyer agrees to pay in dollars, however, Trident has not eliminated transaction exposure, instead it has transferred it to the Belgian buyer whose dollar account payable has an unknown euro value in 60 days
purchasing or selling on open account10





Seller quotes a price to buyer

Buyer places firm order with seller at offered price

Seller ships product and bills buyer

Buyer settles A/R with cash in amount of currency quoted at t1

Quotation Exposure

Time between quoting a price and reaching a contractual sale

Backlog Exposure

Time it takes to fill the order after contract is signed

Billing Exposure

Time it takes to get paid in cash after A/R is issued

Purchasing or Selling on Open Account

Life Span of a Transaction Exposure

borrowing and lending
Borrowing and Lending
  • A second example of transaction exposure arises when funds are loaned or borrowed
  • Example: PepsiCo’s largest bottler outside the US is located in Mexico, Grupo Embotellador de Mexico (Gemex)
    • On 12/94, Gemex had US dollar denominated debt of $264 million
    • The Mexican peso (Ps) was pegged at Ps3.45/$
    • On 12/22/94, the government allowed the peso to float due to internal pressures and it sank to Ps4.65/$
borrowing and lending12
Borrowing and Lending
  • Gemex’s peso obligation now looked like this
    • Dollar debt mid-December, 1994:
      • $264,000,000  Ps3.45/$ = Ps910,800,000
    • Dollar debt in mid-January, 1995:
      • $264,000,000  Ps5.50/$ = Ps1,452,000,000
    • Dollar debt increase measured in Ps
      • Ps541,200,000
  • Gemex’s dollar obligation increased by 59% due to transaction exposure
other causes of transaction exposure
Other Causes of Transaction Exposure
  • When a firm buys a forward exchange contract, it deliberately creates transaction exposure; this risk is incurred to hedge an existing exposure
    • Example: US firm wants to offset transaction exposure of ¥100 million to pay for an import from Japan in 90 days
    • Firm can purchase ¥100 million in forward market to cover payment in 90 days
hedging alternatives
Hedging Alternatives
  • Transaction exposure can be managed by contractual, operating, or financial hedges
  • Contractual hedges: forward, money market, futures, and options
  • Operating and financial hedges use risk-sharing agreements, leads and lags in payment terms, swaps, and other strategies
  • A natural hedge refers to an offsetting operating cash flow
  • A financial hedge refers to either an offsetting debt obligation or some type of financial derivative such as a swap
foreign currency derivatives
Foreign Currency Derivatives
  • Derivatives drive their values from the underlying asset
  • They might be used for two distinct management objectives:
    • Speculation – the financial manager takes a position in the expectation of profit
    • Hedging – the financial manager uses the instruments to reduce the risks of the corporation’s cash flow
  • In the wrong hands, derivatives can cause a corporation to collapse (Barings, Allied Irish Bank), but used wisely they allow a financial manager the ability to plan cash flows
  • The derivatives we will consider are:
    • Foreign Currency Futures
    • Foreign Currency Options
foreign currency futures
Foreign Currency Futures
  • A foreign currency futures contract is an alternative to a forward contract
    • It calls for future delivery of a standard amount of currency at a fixed time and price
    • These contracts are traded on exchanges with the largest being the Chicago Mercantile Exchange (CME)
  • Contract Specifications:
    • Size of contract – called the notional principal, trading in each currency must be done in an even multiple
    • Method of stating exchange rates – “American terms” are used; quotes are in US dollar cost per unit of foreign currency, also known as direct quotes
foreign currency futures17
Foreign Currency Futures
  • Contract Specifications
    • Maturity date – contracts mature on the 3rd Wednesday of January, March, April, June, July, September, October or December
    • Last trading day – contracts may be traded through the second business day prior to maturity date
    • Collateral & maintenance margins – the purchaser or trader must deposit an initial margin or collateral
      • At the end of each trading day, the account is marked to market and the balance in the account is either credited if value of contracts is greater or debited if value of contracts is less than account balance
foreign currency futures18
Foreign Currency Futures
  • Contract Specifications
    • Settlement – only 5% of futures contracts are settled by physical delivery, most often buyers and sellers offset their position prior to delivery date by taking offsetting positions
      • The complete buy/sell or sell/buy is termed a round turn
    • Commissions – customers pay a single commission to their broker to execute a round turn
    • Use of a clearing house as a counterparty – All contracts are agreements between the client and the exchange clearing house. Therefore, there is no counter-party risk
using foreign currency futures
Using Foreign Currency Futures
  • If an investor wishes to speculate on the movement of a currency can pursue one of the following strategies
    • Short position – selling a futures contract based on view that currency will fall in value
    • Long position – purchase a futures contract based on view that currency will rise in value
using foreign currency futures20
Using Foreign Currency Futures
  • Example (cont.): Amy believes that the value of the peso will fall, so she sells a March futures contract
  • By taking a short position on the Mexican peso, Amy locks-in the right to sell 500,000 Mexican pesos at maturity at a set price above their current spot price
  • Amy sells one March contract for 500,000 pesos at the settle price: $0.10958/Ps

Value at maturity (Short position) = – Notional principal  (Spot – Futures)

using foreign currency futures21
Using Foreign Currency Futures
  • To calculate the value of Amy’s position we use the following formula
  • Using the settle price from the table and assuming a spot rate of $0.09450/Psat maturity, Amy’s profit is
  • If Amy believed that the Mexican peso would rise in value, she would take a long position on the peso
  • Using the settle price from the table and assuming a spot rate of $0.11500/Psat maturity, Amy’s profit is

Value at maturity (Short position) = – Notional principal  (Spot – Futures)

Value = – Ps500,000  ($0.09450/Ps – $0.10958/Ps) = $7,540

Value at maturity (Long position) = Notional principal  (Spot – Futures)

Value = Ps500,000  ($0.11500/Ps – $0.10958/Ps) = $2,710

foreign currency options
Foreign Currency Options
  • A foreign currency option is a contract giving the purchaser of the option the right to buy or sell a given amount of currency at a fixed price per unit for a specified time period
    • The most important part of clause is the “right, but not the obligation” to take an action
    • Two basic types of options, calls and puts
      • Call – buyer has right to purchase currency
      • Put – buyer has right to sell currency
    • The buyer of the option is the holder and the seller of the option is termed the writer
foreign currency options24
Foreign Currency Options
  • Every option has three different price elements
    • The strike or exercise price is the exchange rate at which the foreign currency can be purchased or sold
    • The premium, the cost, price or value of the option itself paid at time option is purchased
    • Spot exchange rate in the market
  • There are two types of option maturities
    • American optionsmay be exercised at any time during the life of the option
    • European options may not be exercised until the specified maturity date
foreign currency options25
Foreign Currency Options
  • Options may also be classified as per their payouts
    • At-the-money (ATM) options have an exercise price equal to the spot rate of the underlying currency
    • In-the-money (ITM) options may be profitable, excluding premium costs, if exercised immediately
    • Out-of-the-money (OTM) options would not be profitable, excluding the premium costs, if exercised
foreign currency options markets
Foreign Currency Options Markets
  • Over-the-Counter (OTC) Market – OTC options are most frequently written by banks for US dollars against British pounds, Swiss francs, Japanese yen, Canadian dollars and the euro
    • Main advantage is that they are tailored to purchaser
    • Counterparty risk exists
    • Mostly used by individuals and banks
  • Organized Exchanges – similar to the futures market, currency options are traded on an organized exchange floor
    • The Chicago Mercantile and the Philadelphia Stock Exchange serve options markets
    • Clearinghouse services are provided by the Options Clearinghouse Corporation (OCC)
trident s transaction exposure
Trident’s Transaction Exposure
  • CFO of Trident, has just concluded a sale to Regency, a British firm, for £1,000,000
  • The sale is made in March for settlement due in June (3 months)
    • Assumptions
      • Spot rate is $1.7640/£
      • 3-month forward rate is $1.7540/£ (a 2.27% discount)
      • Trident’s cost of capital is 12.0%
      • UK 3 month borrowing rate is 10.0% p.a.
      • UK 3 month investing rate is 8.0% p.a.
      • US 3 month borrowing rate is 8.0% p.a.
      • US 3 month investing rate is 6.0% p.a.
      • June put option in OTC market for £1,000,000; strike price $1.75/£; priced at $0.0265/£
      • Trident’s foreign exchange advisory service forecasts future spot rate in 3 months to be $1.7600/£
  • The budget rate (lowest acceptable amount) is based on an exchange rate of $1.7000/£
trident s transaction exposure28
Trident’s Transaction Exposure
  • Trident faces four possibilities:
    • Remain unhedged
    • Hedge in the forward market
    • Hedge in the money market
    • Hedge in the futures market
    • Hedge in the options market
trident s transaction exposure29
Trident’s Transaction Exposure
  • Unhedged position
    • If the future spot rate is $1.76/£, then Trident will receive £1,000,000 x $1.76/£ = $1,760,000 in 3 months
    • However, if the future spot rate is $1.65/£, Trident will receive only $1,650,000 well below the budget rate
trident s transaction exposure30
Trident’s Transaction Exposure
  • Forward Market hedge
    • A forward hedge involves a forward contract
    • The forward contract is entered at the time the A/R is created, in this case in March
    • When this sale is booked, it is recorded at the spot rate.
    • In this case the A/R is recorded at a spot rate of $1.7640/£, thus $1,764,000 is recorded as a sale for Trident
    • If the firm wants to cover this exposure with a forward contract, then the firm will sell £1,000,000 forward today at the $1.7540/£
    • In 3 months, Trident will received £1,000,000 and exchange those pounds at $1.7540/£ receiving $1,754,000
    • This sum is $6,000 less than the uncertain $1,760,000 expected from the unhedged position
    • This would be recorded in Trident’s books as a foreign exchange loss of $10,000 ($1,764,000 as booked, $1,754,000 as settled)
trident s transaction exposure31
Trident’s Transaction Exposure
  • Money Market hedge
    • To hedge in the money market, Trident will borrow pounds in London, convert the pounds to dollars and repay the pound loan with the proceeds from the sale
      • To calculate how much to borrow, Trident needs to discount the PV of the £1,000,000 to today
      • £1,000,000/1.025 = £975,610
      • Trident should borrow £975,610 today and in 3 months repay this amount plus £24,390 in interest (£1,000,000) from the proceeds of the sale
      • Trident would exchange the £975,610 at the spot rate of $1.7640/£ and receive $1,720,976 at once (today)
      • This hedge creates a pound denominated liability that is offset with a pound denominated asset thus creating a balance sheet hedge
trident s transaction exposure32
Trident’s Transaction Exposure
  • In order to compare the forward hedge with the money market hedge, we must analyze the use of the loan proceeds
    • Remember that the loan proceeds may be used today, but the funds for the forward contract may not
    • Because the funds are relatively certain, comparison is possible in order to make a decision (the comparison is made on future values)
    • Three logical choices exist for an assumed investment rate for the next 3 months
      • First, if Trident is cash rich the loan proceeds might be invested at the US rate of 6.0% p.a.
      • Second, the loan proceeds can be substituted for an equal dollar loan that Trident would have otherwise taken for working capital needs at a rate of 8.0% p.a.
      • Third, the loan proceeds can be invested in the firm itself in which case the cost of capital is 12.0% p.a.
trident s transaction exposure33

Received today Invested in Rate Future value in 3 months

Trident’s Transaction Exposure
  • Because the proceeds in 3 months from the forward hedge will be $1,754,000, the money market hedge is superior to the forward hedge if the proceeds are used to replace a dollar loan (8%) or conduct general business operations (12%)
  • The forward hedge would be preferable if the loan proceeds are invested at (6%)
  • We will assume the cost of capital as the reinvestment rate

$1,720,976 Treasury bill 6% p.a. or 1.5%/quarter $1,746,791

$1,720,976 Debt cost 8% p.a. or 2.0%/quarter $1,755,396

$1,720,976 Cost of capital 12% p.a. or 3.0%/quarter $1,772,605

trident s transaction exposure34
Trident’s Transaction Exposure
  • A breakeven investment rate can be calculated between forward and money market hedge
  • To convert this 3 month rate to an annual rate,
  • In other words, if Trident can invest the loan proceeds at a rate equal to or greater than 7.68% p.a. then the money market hedge will be superior to the forward hedge
trident s transaction exposure35

Value in US dollars of

Trident’s £1,000,000 A/R

Uncovered yields

whatever the ending

spot rate is in 90 days


Forward rate

is $1.7540/£



Money market hedge

yields $1,772,605




Forward contract hedge

yields $1,754,000














Ending spot exchange rate (US$/£)

Trident’s Transaction Exposure

Trident’s Transaction Exposure

  • Futures market hedge
    • Trident could also cover the £1,000,000 exposure by selling futures contracts now at say $1.7540/£ - most futures contracts are not delivered therefore instead of spot rate you would have purchase price of the futures contract below
    • If spot rate is $1.7600/£ then the result of futures position is:

Value at maturity (Short position) = – Notional principal  (Spot – Futures)

Value at maturity (Short position) = – £1,000,000  ($1.7600/£ – $1.7540/£ )

Value at maturity (Short position) = – $6,000

    • The loss on futures would reduce the value of receivable

Value of receivable = £1,000,000 $1.7600/£ = $1,760,000

    • The net value of receivable is:
    • $1,760,000 – $6,000 = $1,754,000
    • Implied exchange rate of conversion is
    • $1,754,000 / £1,000,000 = $1.7540/£ (Rate at which we sold futures contracts.
trident s transaction exposure37
Trident’s Transaction Exposure
  • Option market hedge
    • Trident could also cover the £1,000,000 exposure by purchasing a put option. This provides the upside potential for appreciation of the pound while limiting the downside risk
      • Given the quote earlier, a 3-month put option can be purchased with a strike price of $1.75/£ and a premium of $0.0265/£
      • The cost of this option would be
trident s transaction exposure38
Trident’s Transaction Exposure
  • Because we are using future value to compare the various hedging alternatives, we need future value of the option cost in 3 months
  • Using a cost of capital of 12% p.a. or 3.0% per quarter, the premium cost of the option as of June would be
    • $26,460  1.03 = $27,254 or $27,254 / £1,000,000 = $0.0273/£
  • Since the upside potential is unlimited, Trident would not exercise its option at any rate above $1.75/£ and would convert pounds to dollars at the spot market
  • If the spot rate is $1.76/£, Trident would exchange pounds on the spot market to receive £1,000,000  $1.76/£ = $1,760,000 less the premium of the option ($27,254) netting $1,732,746
  • If the pound depreciates below $1.75/£, Trident would exercise the put option and exchange £1,000,000 at $1.75/£ receiving $1,750,000 less the premium of the option netting $1,722,746
trident s transaction exposure39
Trident’s Transaction Exposure
  • As with the forward and money market hedges, a breakeven price on the option can be calculated
    • The upper bound of the range is determined by comparison of the forward rate
      • The pound must appreciate above $1.754/£ forward rate plus the cost of the option, $0.0273/£, to $1.7813/£
    • The lower bound of the range is determined by comparison to the strike price
      • If the pound depreciates below $1.75/£, the net proceeds would be $1.75/£ less the cost of $0.0273/£ or $1.722/£
      • Note that the following graph shows the net proceeds of the option contract under varying exchange rates. Net proceeds are not same of a put option payoff diagram because we have exposure to the underlying asset (£)
trident s transaction exposure40

Put Option Strike Price ATM Option $1.75/£

Trident’s Transaction Exposure

Option cost (future cost) $27,254

Proceeds if exercised $1,750,000

Minimum net proceeds $1,722,746

Maximum net proceeds unlimited

Breakeven spot rate (upside) $1.7813/£

Breakeven spot rate (downside) $1.7221/£

net proceeds of alternatives
Net Proceeds of Alternatives

Cell E5 Entry is =IF(A5<$C$2,($C$2-$C$3)*$C$1,(A5-$C$3)*$C$1)

strategy choice and outcome
Strategy Choice and Outcome
  • Trident, like all firms, must decide on a strategy to undertake before the exchange rate changes but how a choice can be made among the strategies?
  • Two criteria can be utilized:
    • Risk tolerance - of the firm,as expressed in its stated policies and
    • Viewpoint – managers’ view on the expected direction and distance of the exchange rate
  • Trident now needs to compare the alternatives and their outcomes in order to choose a strategy
  • There were four alternatives available to manage this account receivable
strategy choice and outcome44

Hedging Strategy Outcome/Payout

Strategy Choice and Outcome

Remain uncovered Unknown

Forward Contract hedge @ $1.754/£ $1,754,000

Money market hedge @ 8% p.a. $1,755,396

Money market hedge @ 12% p.a. $1,772,605

Put option hedge @ strike $1.75/£

Minimum if exercised $1,722,746

Maximum if not exercised Unlimited

managing an account payable
Managing an Account Payable
  • The choices are the same for managing a payable
    • Assume that the £1,000,000 was an account payable in 90 days
  • Remain unhedged – Trident could wait the 90 days and at that time exchange dollars for pounds to pay the obligation
    • If the spot rate is $1.7600/£ then Trident would pay $1,760,000 but this amount is not certain
managing an account payable46
Managing an Account Payable
  • Use a forward market hedge – Trident could purchase a forward contract locking in the $1.754/£ rate ensuring that their obligation will not be more than $1,754,000
  • Use a money market hedge – this hedge is distinctly different for a payable than a receivable
    • Here Trident would exchange US dollars at the spot rate and invest them for 90 days in pounds
    • The pound obligation for Trident is now offset by a pound asset for Trident with matching maturity
managing an account payable47
Managing an Account Payable
  • Using a money market hedge –
    • To ensure that exactly £1,000,000 will be received in 3 months, discount the principal by 8% p.a.
  • This £980,392.16 would require $1,729,411.77 at the current spot rate
managing an account payable48
Managing an Account Payable
  • Using a money market hedge –
    • Finally, carry the cost forward 90 days using the cost of capital in order to compare the payout from the money market hedge
  • This is higher than the forward hedge of $1,754,000 thus unattractive

Managing an Account Payable

  • Futures market hedge
    • Trident could also cover the £1,000,000 exposure by buying futures contracts now at say $1.7540/£
    • If spot rate is $1.7600/£ then the result of futures position is:

Value at maturity (Long position) = Notional principal  (Spot – Futures)

Value at maturity (Long position) = £1,000,000  ($1.7600/£ –$1.7540/£)

Value at maturity (Long position) = $6,000

    • The gain on futures would reduce the value of payable

Value of payable = –£1,000,000 $1.7600/£ = –$1,760,000

    • The net value of payable is:
    • –$1,760,000 + $6,000 = –$1,754,000
    • Implied exchange rate of conversion is
    • $1,754,000 / £1,000,000 = $1.7540/£ (Rate at which we bought futures contracts.
managing an account payable50
Managing an Account Payable
  • Using an option hedge – instead of purchasing a put as with a receivable, you want to purchase a call option on the payable
    • The total cost of an ATM call option with strike price of $1.75/£ and a premium of $0.0265/£:
  • Carried forward 90 days the premium amount is $26,460  1.03 = $27,254 or $27,254 / £1,000,000 = $0.0273/£
managing an account payable51
Managing an Account Payable
  • Using a call option hedge –
    • If the spot rate is less than $1.75/£ then the option would be allowed to expire and the £1,000,000 would be purchased on the spot market
    • If the spot rate rises above $1.75/£ then the option would be exercised and Trident would exchange the £1,000,000 at $1.75/£ less the option premium for the payable

Exercise call option (£1,000,000  $1.75/£) $1,750,000

Call option premium (carried forward 90 days) $27,254

Total maximum expense of call option hedge $1,777,254


Net Proceeds of Alternatives

Cell E5 Entry is =IF(A5>$C$2,($C$2+$C$3)*$C$1,(A5+$C$3)*$C$1)

risk management in practice
Risk Management in Practice
  • Which Goals?
    • The treasury function of most firms is usual considered a cost center; it is not expected to add to the bottom line
    • However, in practice some firms’ treasuries have become aggressive in currency management and act as profit centers
  • Which Exposures?
    • Transaction exposures exist before they are actually booked yet some firms do not hedge this backlog exposure
    • However, some firms are selectively hedging these backlog exposures and anticipated exposures
  • Which Contractual Hedges?
    • Transaction exposure management programs are generally divided along an “option-line;” those which use options and those that do not
    • Also the amount of risk covered may vary. Tare are proportional hedging policies that state which proportion and type of exposure is to be hedged by the treasury
  • Dragon Inc, of Moorhead purchased a Korean company that produces plastic nuts and bolts for auto manufacturers. The purchase price was Won7,030 million. Won1,000 million has already been paid and the remaining Won6,030 million is due in six months. The current spot rate is Won1,200/$, and the 6-month forward rate is Won1,260/$
  • Additional data:
    • Six-month Korean interest rate: 16.00% p.a.
    • Six-month US interest rate: 4.00% p.a.
    • Six-month call option on Korean Won at 1,260 with a premium of Won33.33/$
    • Six-month put option on Korean Won at 1200 with a premium of Won41.67/$
    • Dragon can invest at the rates given above or borrow at 2% p.a. above those rates. Dragon’s cost of capital is 25%.
  • Compare hedging alternatives and make a recommendation.