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    Blades Inc. Case (Options) PDF

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    mazaz
    Blades, Inc. needs to order supplies from a Japanese supplier to be delivered in 2 months and must pay 12.5 million yen. They are considering hedging this transaction using currency options or futures contracts. Currently, options with a 5% higher exercise price have a higher premium due to recent market uncertainty. As an analyst, you must recommend which option Blades should use to hedge or if remaining unhedged is preferable based on expected future yen movements and costs.

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    Blades Inc. Case (Options) PDF

    Uploaded by

    mazaz
    115 views2 pages
    Blades, Inc. needs to order supplies from a Japanese supplier to be delivered in 2 months and must pay 12.5 million yen. They are considering hedging this transaction using currency options or futures contracts. Currently, options with a 5% higher exercise price have a higher premium due to recent market uncertainty. As an analyst, you must recommend which option Blades should use to hedge or if remaining unhedged is preferable based on expected future yen movements and costs.

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    Blades Inc. Case (Options).pdf

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    Blades, Inc. needs to order supplies from a Japanese supplier to be delivered in 2 months and must pay 12.5 million yen. They are considering hedging this transaction using currency options or futures contracts. Currently, options with a 5% higher exercise price have a higher premium due to recent market uncertainty. As an analyst, you must recommend which option Blades should use to hedge or if remaining unhedged is preferable based on expected future yen movements and costs.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    115 views2 pages

    Blades Inc. Case (Options) PDF

    Uploaded by

    mazaz
    Blades, Inc. needs to order supplies from a Japanese supplier to be delivered in 2 months and must pay 12.5 million yen. They are considering hedging this transaction using currency options or futures contracts. Currently, options with a 5% higher exercise price have a higher premium due to recent market uncertainty. As an analyst, you must recommend which option Blades should use to hedge or if remaining unhedged is preferable based on expected future yen movements and costs.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    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 12.5 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 unhedged if the yen becomes more stable
    someday.

    Ben Holt, Blades’ chief 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 percent above the existing spot rate for
    a transaction 2 months beyond its order date, as long as the option premium is no more than 1.6
    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 $.0072, and the firm purchased a call option with an exercise price of $.00756,
    which is 5 percent above the existing spot rate. The premium for this option was $.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 $.0072, but the option premium for a call option with an exercise price of $.00756 was now
    $.0001512. An alternative call option is available with an expiration date of 2 months from now;
    it has a premium of $.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 $.00792. The
    table below summarizes the option and futures information available to Blades:
    As an analyst for Blades, you have been asked to offer insight on how to hedge. Answer
    the following questions:

    1. If Blades uses call options to hedge its yen payables, should it use the call option with
    the exercise price of $.00756 or the call option with the exercise price of $.00792? Describe the
    tradeoff.

    2. Should Blades allow its yen position to be unhedged? Describe the tradeoff.

    3. Assume there are speculators who attempt to capitalize on their expectation of the
    yen’s movement over the 2 months between the order and delivery dates by either buying or
    selling yen futures now and buying or selling yen at the future spot rate. Given this information,
    what is the expectation on the order date of the yen spot rate by the delivery date? (Your answer
    should consist of one number.)

    4. Assume that the firm shares the market consensus of the future yen spot rate. Given
    this expectation and given that the firm makes a decision (i.e., option, futures contract, remain
    unhedged) purely on a cost basis, what would be its optimal choice?

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