Futures and Options

Topics: United States dollar, Currency, Canadian dollar Pages: 3 (1120 words) Published: May 7, 2011
Pixonix Inc. is a graphic design company that operates in Toronto, Canada. However, though it is based in Canada, Pixonix Inc. buys the company’s licensed proprietary tools and software from a U.S. company every year. The cost of these tools and software is 7.5 million U.S. dollars. Thus, every year at the end of January, Pixonix Inc. has to endure an expense of 7.5 million dollars. According to the case, currently the Canadian dollar is appreciating against the U.S. dollar. Therefore the Canadian dollar is performing well. However, considering the recent history of the CAD-USD exchange rate relationship, the Canadian dollar is known to reach record highs, and then trades at parity, followed by record low. Moreover, the largest international trader of Canadian Dollars, RBC forecasts that though the Canadian dollar will further appreciate, likely chances are that by ‘second half’ of the next year it will depreciate to a rate below parity. Therefore Pixonix Inc. faces the risk of the USD appreciating, and thus the expense of 7.5 million US dollars will cost more in terms of Canadian dollars; they will have to pay more Canadian dollars for each US dollar. So Cain’s dilemma is that should she hedge her company’s position to protect them from exchange rate risk or should she just let things continue the way they are. We believe that before buying a hedge option, she should forecast the profit or loss she may incur with the hedge. So, since she expects the USD to appreciate, it would be advisable for her to either short a forward contract or call option. A forward contract is an agreement between a corporation and a financial institution to exchange a specific amount of a currency at a specified exchange rate (known as the forward rate), on a specified date in the future. However, the disadvantage of a forward contract is that both the parties are obligated to fulfill their duties; thus the buyer must buy and the seller must sell. In the case of Pixonix, Cain...
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