- 10 Marks
FM – MAY 2019 – L2 – Q3b – Foreign exchange risk and currency risk management | Hedging with options
Calculate profit or loss from option contracts and advise on whether to exercise the options for Universal Plastics Ghana Ltd.
Question
Universal Plastics Ghana Ltd imported raw materials from U.S.A. and Europe for the manufacture of plastic products. The company entered into option contracts with ZAA Bank Ghana Ltd to hedge its six months’ currency risk or exposure. The details of the option contracts are as follows:
| Details | Transaction Amount | Strike Price/ Exchange Rate | Spot Rate on Maturity Date | Option Premium Paid to the Bank |
|---|---|---|---|---|
| OPTION A | Bought Call option to buy USD against GH¢ | US$10m | USD/GH¢ 4.7 | USD/GH¢ 4.5 |
| OPTION B | Bought Call option to buy EURO against GH¢ | EUR 8m | EUR/GH¢ 5.9 | EUR/GH¢ 6.3 |
Required:
- Calculate the profit or loss of OPTION A and advise Universal Plastics Ghana Ltd whether to exercise or not. (4 marks)
- Calculate the profit or loss of OPTION B and advise Universal Plastics Ghana Ltd whether to exercise or not. (4 marks)
- Calculate the overall profit or loss on the decision to hedge based on (i) and (ii) above. (2 marks)
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