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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. **Key Points:** - Selling a call option creates unlimited downside risk if the EUR depreciates sharply - The premium received is fixed, but the loss potential on the receivable is unlimited - A forward contract would provide complete protection by locking in the exchange rate - The CFO's strategy exposes the company to currency risk on the downside while capping upside potential
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In assessing the potential hedging strategy, the CFO thinks that selling an option is better than taking a forward position because if the EUR appreciates against the USD, XYZ can take delivery of the USD at USD 1.19 per EUR 1, while if the EUR depreciates against the USD, the contract will not be exercised and XYZ will pocket the premium obtained from selling the call option. What can be concluded about the CFO's analysis?
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.