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Answer: CFO's analysis is not correct. The company will suffer if the EUR goes up sharply.
## Explanation **Analysis of the CFO's reasoning:** **Scenario 1: Forward Contract** - Company locks in selling EUR at 1.33 USD/EUR - Guaranteed receipt: 5,000,000 × 1.33 = USD 6,650,000 **Scenario 2: Selling Call Option** - Company sells a call option with strike 1.34 USD/EUR - Premium received: Unknown amount - If EUR goes up above 1.34: Option is exercised, company sells EUR at 1.34 - If EUR goes down below 1.34: Option expires worthless, company keeps premium **Problem with CFO's analysis:** 1. The CFO incorrectly states that if EUR goes up, XYZ can "take delivery of the USD at 1.34" - actually, when selling a call option, if the EUR goes up, the company is forced to sell EUR at 1.34 2. If EUR rises sharply above 1.34, the company misses out on the upside potential beyond 1.34 3. The forward contract provides certainty at 1.33, while selling the call caps the upside at 1.34 plus premium 4. The risk is that if EUR rises significantly above 1.34, the company would have been better off without any hedge **Conclusion:** The CFO's analysis is flawed because the company will suffer if the EUR goes up sharply, as they are capped at 1.34 plus premium, while they could have benefited from the higher spot rate without the hedge. The correct answer is **Option B**.
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Company XYZ operates in the U.S. On April 1, 2009, it has a net trade receivable of EUR 5,000,000 from an export contract to Germany. The company expects to receive this amount on Oct. 1, 2009. The CFO of XYZ wants to protect the value of this receivable. On April 1, 2009, the EUR spot rate is 1.34, and the 6-month EUR forward rate is 1.33. The CFO can lock in an exchange rate by taking a position in the forward contract. Alternatively, he can sell a 6-month EUR 5,000,000 call option with strike price of 1.34. The CFO thinks that selling an option is better than taking a forward position because if the EUR goes up, XYZ can take delivery of the USD at 1.34, which is better than the outright forward rate of 1.33. If the EUR goes down, the contract will not be exercised. So, XYZ will pocket the premium obtained from selling the call option.
What can be concluded about the CFO's analysis?
A
CFO's analysis is correct. The company is better off whichever way the EUR rate goes.
B
CFO's analysis is not correct. The company will suffer if the EUR goes up sharply.
C
CFO's analysis is not correct. The company will suffer if the EUR moves within a narrow range.