Mini Case 2

Topics: Foreign exchange market, Exchange rate, Inflation Pages: 5 (1534 words) Published: February 20, 2013
MiniCase 2

1. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0.00756 or the call option with the exercise price of $0.00792? Describe the tradeoff.

The corporation needs to purchase supplies with foreign currency. To hedge against the possible appreciation of the foreign currency's value, the corporation can purchase a call option. Both options have to pay a premium for the option. The purchase price or exercise price of option A is $0.00756 plus a premium paid on this respective option of $.0001512 resulting in a total cost of $.0077112 per yen. The purchase or exercise price of option B is $0.00792 plus a premium paid of $.0001134 resulting in a total cost of $.0080334 per yen. Option A is the better option, relatively. Option B has a higher exercise price, though its exercise price is lower, the overall result is a higher amount paid for yen if the option is exercised. If the option is likely not to be exercised, option B is the best choice. The corporation would only have to pay the premium price and not the exercise price. In this case, option B's premium price is lower. The trade off is between a lower exercise price, higher premium price, option A, that better hedges against the yen if it were to appreciate in value (exercising the option) and a higher exercise price, lower priced premium that reduces cost if the hedge does not appreciate in value (the option is not exercised).

2.Should Blades allow its yen position to be unhedged?  Describe the tradeoff. 

The case stated that “the futures price on yen has historically exhibited a slight discount from the existing spot rate”. In this case, the exercise price of the option may be higher relative to the future spot rate encouraging the investor to let the option expire. If the option were to expire the corporation would still have to pay the premium and any other non-exercise costs. An unhedged position might be the best position if this were to occur because there would be no premium charges. The disadvantage to an unhedged position is that if the exercise price of the option were to be 'in the money', the spot exchange rate is greater than the exercise price, there would be no hedged stance against the yens appreciated value causing a higher cost to the foreign currency payable. Chap 6 

1.Did the intervention effort by the Thai government constitute direct or indirect intervention? Explain.

The Thai government is trying to smooth exchange rate movements by encouraging appreciation of its currency through direct intervention. It is exchanging foreign currencies for its home currency in the exchange market, this will put upward pressure on home currency. Specifically, the Thai government swapped baht reserves for dollar reserves at other central banks and then used its dollar reserves to purchase the baht in the foreign exchange market.

2.Did the intervention by the Thai government constitute sterilized or non sterilized intervention? What is the difference between the two types of intervention? Which type do you think would be more effective in increasing the value of the baht? Why? (Hint: Think about the effect of nonsterilized intervention on U.S. interest rates.)

The intervention of the Thai government is an example nonsterilized intervention because the Thai government did not simultaneously engage in offsetting the described transactions in the securities market. This would have resulted in the net money supply to be unchanged. Both interventions will achieve the same exchange of currency in the exchange market but sterilized intervention requires another transaction to prevent adjustments in the money supply. An increase in money supply, as would be the effect in nonsterilized intervention, would cause home interest rates to drop and makes more money available for consumers to borrow from banks. Investors may transfer funds to foreign countries, the US, to take...
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