Blades Inc Solution of Ifm

Get an answer from tutors to this homework question now: Chapter 5 Blades, Inc. Case Use of Currency Derivative Instruments Blades, Inc. needs to order supplies 2 months ahead of the delivery date. It is considering an order from a Japanese supplier that requires a payment of 12. 5 million yen payable as of the delivery date. Blades has two choices: Purchase two call options contracts (since each option contract represents 6,250,000 yen). Purchase one futures contract (which represents 12. million yen). The futures price on yen has historically exhibited a slight discount from the existing spot rate. However, the firm would like to use currency options to hedge payables in Japanese yen for transactions 2 months in advance. Blades would prefer hedging its yen payable position because it is uncomfortable leaving the position open given the historical volatility of the yen. Nevertheless, the firm would be willing to remain un-hedged if the yen becomes more stable someday.

Ben Holt, Blades chief financial officer ( CFO), prefers the flexibility that options offer over forward contracts or financial officer ( CFO), prefers the flexibility that options offer over forward contracts or futures contracts because he can let the options expire if the yen depreciates. He would like to use an exercise price that is about 5 percent above the existing spot rate to ensure that Blades will have to pay no more than 5 per-cent above the existing spot rate for a transaction 2 months beyond its order date, as long as the option premium is no more than 1. percent of the price it would have to pay per unit when exercising the option. In general, options on the yen have required a premium of about 1. 5 percent of the total transaction amount that would be paid if the option is exercised. For example, recently the yen spot rate was $0. 0072, and the firm purchased a call option with an exercise price of $0. 00756, which is 5 percent above the existing spot rate. The premium for this option was $0. 0001134, which is 1. 5 percent of the price to be paid per yen if the option is exercised.

A recent event caused more uncertainty about the yen s future value, although it did not affect the spot rate or the forward or futures rate of the yen. Specifically, the yen s spot rate was still $0. 0072, but the option premium for a call option with an exercise price of $0. 00756 was now $0. 0001512. An alter-native call option is available with an expiration date of 2 months from now; it has a premium of $0. 0001134 (which is the size of the premium that would have existed for the option esired before the event), but it is for a call option with an exercise price of $0. 00792. The table below summarizes the option and futures information available to Blades: the option premium for a call option with an exercise price of $0. 00756 was now $0. 0001512. An alter-native call option is available with an expiration date of 2 months from now; it has a premium of $0. 0001134 (which is the size of the premium that would have existed for the option desired before the event), but it is for a call option with an exercise price of $0. 00792.

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The table below summarizes the option and futures information available to Blades: Before Event After Event Spot rate $. 0072 $. 0072 $. 0072 Option Information Exercise price ($) $. 00756 $. 00756 $. 00792 Exercise price (% above spot) 5% 5% 10% Option premium per yen ($) $. 0001134 $. 0001512 $. 0001134 Option premium (% of exercise price) 1. 5% 2. 0% 1. 5% Total premium ($) $1,417. 50 $1,890. 00 $1,417. 50 Amount paid for yen if option is exercised (not including premium) $94,500 $94,500 $99,000 Futures Contract Information Futures price $. 06912 $. 006912 As an analyst for Blades, you have been asked to offer insight on how to hedge. 1. What are the advantages and disadvantages for Blades to use currency option contracts and currency futures contracts to hedge its 12. 5 million yen payables respectively? 2. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0. 00756 or the call option with the exercise price of $0. 00792? What are differences between these two alternatives? 3.

Given the above information, how may you take advantages of this situation? 4. Assume the standard deviation for yen is about $0. 0005. If you believe that the future spot rate will likely be two standard deviations above and below the expected spot rate (0. 006912) by the delivery date, what are your maximum gain and loss for option contracts and future contract respectively? Please draw a contingency diagram for each type of contract and also mark the maximum gain, loss, and a break-even price point for each type of contract in your answer.

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