Dodge Fahar Corp. will receive 1 million euros in one year. It is considering al

Question

Dodge Fahar Corp. will receive 1 million euros in one year. It is considering alternative hedging strategies for this receivable using (1) forward contracts, (2) money market instruments, or (3) currency options contracts. Manager A and Manager B make the following statements:

                           Manager A: Option hedge allows the company to control the downside risk while retaining the upside potential. The company should always use option hedge.

                           Manager B: With forward hedge, the company knows the future proceeds in dollar of the euro receivable. With MMH, the company does not know the future proceeds in dollar until after one year when they sell the euros.

a.

Only manager A is correct.

b.

Only manager B is correct.

c.

Both managers are correct.

d.

Both managers are not correct.

a.

Only manager A is correct.

b.

Only manager B is correct.

c.

Both managers are correct.

d.

Both managers are not correct.

Explanation / Answer

a. Only Manager A is correct

Under an option hedge, the hedger can decide whether he should exercise the option or not in the future. Thus, it allows him to earn income while protecting him from unlimited losses.

Manager B is wrong because in MMH also it is possible to know the future proceeds.

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