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FRM Part I · FRM Exam Part I · Foreign Exchange Markets

A UK exporter hedges a USD 2,000,000 receivable using a currency option rather than a forward. Compared with a forward hedge, which statement is correct about the option hedge?

The option hedge needs an upfront premium but keeps the upside if the dollar strengthens. The exporter has a right, not an obligation, to sell dollars at the strike, so it can ignore the option when spot is more favorable. A forward locks the rate with no premium and no upside.

  1. AIt requires paying an upfront premium but retains the benefit if the dollar strengthens against sterlingCorrect
  2. BIt costs nothing upfront and fixes the sterling value of the receivable
  3. CIt removes the benefit of a stronger dollar while protecting against a weaker dollar, with no premium
  4. DIt obligates the exporter to exchange dollars at the strike regardless of the spot rate

Explanation

The exporter buys a put on USD (call on GBP) to protect against dollar weakness. The premium is paid upfront, but if USD strengthens, the option lapses and the exporter sells dollars at the better spot rate. A forward fixes the rate with no upside and no premium.

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