The company Pixonix Inc is based in Canada and its revenues are based in CAD, however Pixonix dealt with US firms, so a majority of Pixonix's expenses were paid in US Dollars. Of key interest is the annual payment of US$7.5million at the end of January each year as well as the payments made at the end of June each year (which required the CAD to be converted to USD). Recently the CAD has been appreciating and positively affecting Pixonix's profitability, however since some of the cash flows needed to be converted to USD Pixonix is exposed to currency exchange risk. Cain's dilemma is to choose between either to purchase a forward contract and lock the cost of the January US$7million or to purchase call options for the USD for $7.5million, and which course of action will provide the highest benefit and lowest risk possible under different exchange rates. Should the CAD depreciate with respect to the USD Pixonix costs would be higher. Question #2
Various Hedging Options:
a) Purchase a forward contract
Cain can eliminate exchange rate risk by engaging in a forward contract by locking in the exchange rate for the CAD/USD. To benefit when purchasing a forward contract to sell CAD for USD, the CAD should have depreciated at the time of the payment relative to today. To benefit when purchasing a forward contract to buy USD for CAD, the USD should have appreciated at the time of the payment relative to today. b) Purchase a call option
Cain can eliminate exchange risk by using a call option. The call option would be to purchase USD in the future. To benefit from this option Cain will need to exercise it only of the CAD/USD depreciates below the strike price of the option. c) No action (leave the USD exposure unhedged)
By taking zero action Cain will encounter one of two scenarios (barring the rates stay the same): In the case that the CAD appreciates in respect to the USD; Pixonix will pay less...