FN 316 International Financial Management
Blades Inc. Chapter 5
1) If Blades used call options to hedge its Yen in payables, they are presented with 2 options. They can hedge at a lower exercise price (.00756) with a higher premium (2%); of they can hedge at a higher exercise price (.00792) with a lower premium (1.5%). Traditionally, the premiums are normally 1.5%, however due to recent uncertainty they have risen. This presents a tradeoff between an exercise price and premium, where as the exercise price rises, the premium falls, as it is cheaper because there is less likelihood of that exercise price being reached. Due to this, Blades should not change their strategy of hedging at a spot rate of no more than 5% above the spot rate due to the slightly increased premium. The 5% difference in spot rates is much more significant than the .5% difference in premium price, especially since the 1.5% premium is being applied to a larger exercise price (.00792). The larger exercise price creates a larger premium, reducing the difference that the company gains from the cheaper premium.
2) In this situation Blades should not allow its position to remain unhedged. Due to recent uncertainty about the Yens future value, it would be wise to lock in a rate and pay an extra premium, rather than running the risk of getting beat very badly by a poor exchange rate. This is primarily due to the large size of the transaction, as 12.5 million yen are expected to be paid on this date. Given a smaller transaction, I may advise differently.
3) In a situation where speculators seeking to capitalize on the current market situation, the equilibrium price of the Yen should move and the spot...
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