Basic option pricing at expiration: a European and American option, both with the same exercise price will have the same terminal value.American option pricing relationships: an American call or put option can be exercised at any time prior to expiration.oWorth more all given equalsEuropean option pricing relationships: can only be exercised at expiration.Impact on premiums from ohigher/lower spot rateoExercise rateoInterest rates in both currency/countriesoRelative level of interest ratesChapter 83 types of currency exposures:oTransaction: sensitivity of realized domestic currency values of the firms contractual cash flows denominated in foreign currencies to unexpected exchange rate changesoEconomic: the extent to which the value of a firm can be affected by unanticipated changes in exchange ratesoTranslation: refers to the potential by which a firm’s consolidated financial statements can be affected by changes in exchange ratesWays of hedging transaction exposure with financial productsoForward market hedge: imports. If you expect to owe foreign currency in the future, you can hedge by agreeing today to buy the foreign currency in the future at a set price by entering into a long position in a forward contract.The firm may sell (buy) its foreign currency receivables (payables) forward to eliminate its exchange risk exposure. oForward market hedge: exportsIf you going to receive foreign currency in the future, you can agree to sell the currency in the future at a set price by enteringthe short position in a forward contract.oMoney market hedge: self-financing.Lending and borrowing in the domestic and foreign money markets. Firms borrows (lend) in foreign currency to hedge its foreign currency receivables (payable) thereby matching its assets and liabilities in the same currency.oOption market hedge: The firm may buy a foreign currency call (put) option to hedge its foreign currency payables (receivables).Ways of hedging transaction exposure with operations techniques:oHedging through invoice currency
The firm can shift, share or diversify exchange risk by appropriately choosing the currency of invoice. oHedging via lead and lagIf a currency is appreciating, pay those bills denominated in that currency early, let customers in that country pay late as long as they pay in that currencyIf a currency is depreciating, give incentives to customers who owe you in that currency to pay early; pay your obligations as
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