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Answer: The CFO's analysis is not correct and the company will suffer if the EUR depreciates sharply against the USD.
The CFO's analysis is incorrect because there is unlimited downside risk. The option premium received is a fixed amount, and if the EUR depreciates sharply, the value of the underlying receivable goes down as well. If instead the EUR moves in a narrow range, that would be good, but there is no guarantee of course that this will occur.
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Company XYZ, a US-based firm, holds net trade receivables of EUR 5,000,000 from a German export contract, due to be received on December 1, 2019. On June 1, 2019, the spot exchange rate is USD 1.19/EUR, and the six-month forward rate is USD 1.17/EUR. To hedge this exposure, the CFO is considering two alternatives:
In assessing the potential hedging strategy, the CFO argues that selling the call option is preferable to using a forward contract. Their reasoning is:
What can be concluded about the CFO’s analysis of these two hedging strategies?
A
The CFO's analysis is correct and the company is better off whichever way the EUR rate goes.
B
The CFO's analysis is not correct and the company will suffer if the EUR appreciates sharply against the USD.
C
The CFO's analysis is not correct and the company will suffer if the EUR moves within a narrow range.
D
The CFO's analysis is not correct and the company will suffer if the EUR depreciates sharply against the USD.