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Answer: ABC would be better off by entering into a forward contract if EUR depreciates against USD by an amount significantly larger than USD 0.03 per EUR 1.
## Explanation **D is correct** because: - **Forward contract**: Locks in selling price at USD 1.10 per EUR 1 - **Selling call option**: Strike price is USD 1.07 per EUR 1, ABC receives premium **Key analysis**: - If EUR depreciates significantly (more than USD 0.03 per EUR 1), the spot rate would be below USD 1.07 - With forward contract: ABC sells at USD 1.10 regardless of spot rate - With sold call option: If spot rate < USD 1.07, option expires worthless, ABC keeps premium but sells at lower spot rate - The profit from forward contract (USD 1.10) exceeds the combined benefit from premium + lower spot rate when EUR depreciates significantly **Why other options are incorrect**: - **A**: Incorrect - Option profitability depends on FX rate movement direction and magnitude - **B**: Incorrect - If EUR appreciates significantly above USD 1.07, ABC would be better with forward contract only if premium < 0.03 - **C**: Incorrect - If EUR appreciates by less than USD 0.03 (spot between 1.07-1.10), outcome depends on premium amount; forward may not be clearly better The forward contract provides certainty at USD 1.10, while selling the call option exposes ABC to downside risk if EUR depreciates significantly.
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A portfolio manager at company ABC is examining the company's outstanding FX exposures as of June 1, 2023. The manager decides to hedge a net receivable of EUR 5,000,000 due on December 1, 2023. On June 1, 2023, the EUR spot rate is USD 1.07 per EUR 1, and the 6-month EUR forward rate is USD 1.10 per EUR 1. The manager investigates whether it is better to lock in the exchange rate by taking a position in the forward contract and locking the selling price in 6 months or to sell a 6-month EUR 5,000,000 call option with a strike price of USD 1.07 per EUR 1. Which of the following statements is most likely correct?
A
ABC would be better off by selling an option contract regardless of how large the change in the FX rate is and in which direction EUR moves relative to USD.
B
ABC would be better off by entering into a forward contract if EUR appreciates against USD by an amount significantly larger than USD 0.03 per EUR 1 and the call option premium is more than 0.03.
C
ABC would be better off by entering into a forward contract if EUR appreciates against USD by less than USD 0.03 per EUR 1.
D
ABC would be better off by entering into a forward contract if EUR depreciates against USD by an amount significantly larger than USD 0.03 per EUR 1.