Corporate Uses and Abuses of Currency Options Prof
Corporate Uses and Abuses of Currency Options Prof. Ian Giddy New York University
Forwards vs Futures vs Options l l Good credit: Forward usually best Sometimes, Money Market Hedge better u Perfect market: same (covered int. arb. ) u Imperfect market: MMH may be better l Credit problem: Futures u But: limited and standardized u Requires margin and daily settlement l Uncertain future cash flows: u Liquid instrument (futures/forwards to assure flexibility u Options sometimes advisable Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options Known cash flows + option hedge = naked option u. Hedging a known position u. Covered call writing u. Hedging with “cheap options” u. Hedging with “free options” u. Hedging contingent risk u. Options receive favorable accounting treatment Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options: 1. Hedging a Known Position l Example: Buy a Swiss franc put to hedge a royalty payment to be received from Switzerland Gain or Loss + 0 Value of Swiss franc Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options: 1. Hedging a Known Position l Example: Buy a Swiss franc put to hedge a royalty payment to be received from Switzerland Gain or Loss Buy a Put Value of Swiss franc Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options: 1. Hedging a Known Position l Example: Buy a Swiss franc put to hedge a royalty payment to be received from Switzerland Gain or Loss Net effect: Like buying a call Value of Swiss franc Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Combining Options Long a currency Gain or Loss Plus: Buy a put Net effect: Like buying a call Value of Swiss franc Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Put-Call Parity Sell a Call Gain or Loss Plus: Buy a put Net effect: Short the currency Value of Swiss franc Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Don’t Kid Yourself Option combinations: Owe currency + buy call = Buy put Own currency + buy put = Buy call Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options: 2. Covered Call Writing l ICI proposes. . . + Copyright © 1997 Ian H. Giddy = Options 03: 26 PM Uses and
Using Currency Options: 3. Hedging with “Cheap Options” l Example: Buy an out-of-the-money put to hedge a Swiss franc receivable + = Question: When should a firm buy ATM options? l Answer: When the firm’s view of volatility exceds that of the market l Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
What Influences Option Prices? Forward relative to strike l Time to expiration l Volatility l Interest rate l Option Value Currency Value Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Using Currency Options: 4. Hedging with “Free Options” l Currency collar or range forward l Eg Exposure is obligation to pay for Japanese imports in 60 days + + = Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Case Study: “Options Trip” Japanese exporters long US dollars Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Case Study: “Options Trip” $10 million + Copyright © 1997 Ian H. Giddy = Options 03: 26 PM Uses and
Case Study: “Options Trip” $10 million + = $30 million + Copyright © 1997 Ian H. Giddy = Options 03: 26 PM Uses and
Using Currency Options: 5. Hedging Contingent Risk Example 1: T. I bidding to supply chips to Saudi Arabia l Example 2: ABB lobbying to win highspeed rail contract in Florida l Problem: Wrong contingency l Solution: Event-contingent options l Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
6. Using Options to get Hedge Accounting Treatment Pfizer, the US drug company, uses forwards to hedge short-term foreigncurrency payables and receivables l Pfizer uses long-dated options, as far out as 2 years, to hedge anticipated sales. This gets expensive! l Reason: GAAP would treat forwards used to hedge future, uncertain, sales as speculative, to be marked-to-market. l Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
When Should Companies use Options to Hedge? l Hedge natural exposure u. Example: Reeves sells printing blankets with fixed local-currency prices in Europe l Hedge against extreme events that threaten the company’s business. u. Example: GE could buy deep out-of-themoney options on yen. Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
When Use Options to Take a View? View on direction l View on volatility l Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Why Use Currency Options? Protect against downside risk l Earn income from covered option writing l Buy “cheap options” l Buy “free options” l Hedge event-contingent risk l View on both volatility and direction l Hedge against financial distress l Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
Which Instrument? Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
A Corporate Foreign Exchange Roadmap UNDERSTANDING THE EXCHANGE RISK MANAGEMENT PROBLEM n Value of hedging n Goals n Nature of the business MEASUREMENT OF EXPOSURE ACCOUNTING Examples: n Sourcing flexibility n Pricing strategy n Market diversification Copyright © 1997 Ian H. Giddy ECONOMIC NATURE OF THE CASH FLOW EXPOSURE: n One-shot? n Linear? n Contingent on exchange rates? n Contingent on other events? HEDGING METHODS OPERATIONAL TRANSACTION FINANCIAL Linear n Forwards n Futures n Debt n Currency swaps Exchange-rate contingent n Options n Debt with option features Contingent on other events n Event options n Probability-based hedging Options 03: 26 PM Uses and
Copyright © 1997 Ian H. Giddy Options 03: 26 PM Uses and
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