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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

A company expects to receive JPY in three months and wants protection against yen weakening while retaining benefit if yen strengthens, but wishes to reduce the upfront premium. It buys a put on JPY and sells a call on JPY with a higher strike. Which statement about this strategy is correct?

The strategy is a collar. Buying the put sets a minimum effective rate, while selling the higher-strike call earns premium that reduces the cost but caps the benefit from favourable moves beyond the call strike, so the exposure is fixed within a range.

  1. AIt is a collar, which caps the upside gain at the call strike in exchange for lower net premiumCorrect
  2. BIt is a straddle, which profits from large moves in either direction
  3. CIt is a forward contract, which fixes the rate exactly
  4. DIt is a butterfly, which limits both loss and gain around the spot rate

Explanation

Buying a put at a floor strike and selling a call at a higher cap strike creates a collar (range forward type). The call premium received offsets the put cost, but gains above the cap are surrendered. A straddle would involve buying both a put and a call at the same strike.

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