Option Trading Strategies

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Robert F. Bruner, Kenneth M. Eades, Michael J. Schill, Case Studies in Finance: Managing for Corporate Value Creation, Sixth Edition, McGraw Hill, 2010; Excel Template: http://highered.mcgraw-hill.com/sites/0073382450/student_view0/supplemental_cases.html Study Questions 1. How profitable is the original sale to Novo once the exchange-rate changes are acknowledged? How might the exchange-rate risk, which affected the value of the order, have been managed? 2. Assuming Baker agrees to the new Novo sale, determine the present value of the expected future cash inflow assuming: (1) there is no hedge, (2) the company hedges using a forward contract, and (3) the company hedges using the money market. Finding a present value is necessary for the following reason: With no hedge or a with forwardcontract hedge, the cash flow will occur at the time of payment by Novo. With the money-market hedge, Baker receives a cash flow immediately. 3. Are the money markets and forward markets in parity? 4. How profitable will the follow-on order be? Would you make this new sale? Supporting Spreadsheet Files Excel Template: http://highered.mcgraw-hill.com/sites/0073382450/student_view0/supplemental_cases.html For students: Case_37.xls Discussion Questions 1. What was the revenue actually received from the original order, and how does it affect the profitability of that order? 2. How might exchange-rate risk be managed? 3. Assume Baker decides to take the follow-on order, how might the forward-contract and money-market rates be used to hedge the future expected inflow? 4. Why do we see a preference for the forward-market hedge over the money-market hedge? 5. With the forward or money-market hedge in place, can the company be completely sure there will be no exchange risk? 6. Should Baker accept the new order?

This case and teaching note were prepared by Associate Professor Marc Lipson. Copyright  2007, 2008 by the University of Virginia Darden School...
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