Question8 An Australian company decided to hedge a EUR 1 million account payable in 3 months using option contracts. The current spot exchange rate is AUD1.60/EUR and the strike price of the call and put options are both AUD1.60/EUR. Which of the following statements is TRUE? Select one alternative: To hedge the currency risk, the company needs to buy call options. If the spot price becomes AUD1.50/EUR in three months, the company should let options expire. To hedge the currency risk, the company needs to buy call options. If the spot price becomes AUD1.50/EUR in three months, the company should exercise the options. To hedge the currency risk, the company needs to buy put options. If the spot price becomes AUD1.50/EUR in three months, the company should exercise the options. To hedge the currency risk, the company needs to buy put options. If the spot price becomes AUD1.50/EUR in three months, the company should let options expire. ResetMaximum marks: 2 Flag question undefined

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BlackTom AI · Accepted Answer

First, restating the scenario helps frame the analysis: an Australian company has a EUR 1 million account payable due in 3 months and wants to hedge this currency risk. The current spot is AUD1.60/EUR, and the strike price for both call and put options is AUD1.60/EUR. The task is to identify which statement is TRUE.
Option A: To hedge the currency risk, the company needs to buy call options. If the spot price becomes AUD1.50/EUR in three months, the company should let options expire. This option is consistent with hedging a payables exposure in EUR. A call option on EUR gives the right to buy EUR with AUD at the strike, so in a scenario where EUR strengthens (i.e., AUD弱 or EUR/ AUD higher)? Actually, a lower AUD/EUR means EUR is cheaper in AUD; the spot of 1.50 is below the strike of 1.60, so exercising would be unattractive and letting the option expire is optimal. Therefore, this choice correctly identifies the hedge instrument and the exercise decision under a scenario where the spot falls below the strike. 
Option B: To hedge the currency risk, the company needs to buy call options. If the spot price becomes AUD1.50/EUR in three months, the company should exercise the options. Exercising a call option with a strike of 1.60 when the market is 1.50 would mean paying 1.60 to acquire EUR instead of buying at the market 1.50, which is economically irrational. So exercising here is incorrect. 
Option C: To hedge the currency risk, the company needs to buy put options. If the spot price becomes AUD1.50/EUR in three months, the company should exercise the options. A put option on EUR would give the right to sell EUR for AUD at the strike, which would be useful if you held EUR, but the company has a payable (needs to acquire EUR), not a receivable. Therefore buying puts is not the correct hedge for a payable and the exercise assumption is flawed. 
Option D: To hedge the currency risk, the company needs to buy put options. If the spot price becomes AUD1.50/EUR in three months, the company should let options expire. Similar to Option C, puts are not the appropriate hedge for a payable obligation in EUR, since you would not benefit from selling EUR forward in this context; and in this case the market price is favorable (EUR cheaper in AUD), so letting the option expire would be the sensible action if you had bought puts. 
In summary, Option A correctly matches the hedging approach (buy call options) and the optimal action given a fall in spot to 1.50 AUD/EUR (let the options expire rather than exercise). The other options either propose the wrong hedging instrument for a payable exposure (puts instead of calls) or propose an exercise decision that would be economically irrational under the given market move.

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