Explanation:
Selling an option provides downside protection in the amount of the premium. Beyond that, the company will suffer from further euro depreciation. Selling a forward would instead lock in the forward rate of the contract.
(Book 3, Module 30.1, LO 30.d)
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Question 13
Cascade [a public limited company (PLC)] is a U.K. pharmaceutical company. It has just sold an innovative drug to Germany and has recorded a €3 million receivable on its accounts. The money will be received on August 2, which is three months from today. A risk manager with Cascade PLC is considering two options to hedge his company's euro exposure: either to sell a forward contract on the euro at €1.15 or sell a call option on the euro at €1.20. He believes that it is safer for the company to sell the option because if the euro appreciates, he would receive €1.20 from the option as opposed to €1.15 from the forward. The risk manager's analysis is:
A
correct.
B
incorrect, and the company will suffer if the euro appreciates.
C
incorrect, and the company will suffer if the euro depreciates.
D
incorrect, and the company will suffer if the euro stays in its current trading range.
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