Hedging with options – NBC Institute

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

Question

i) Explain the term intrinsic value of an option. (1 mark)

ii) DUU Ghana Ltd bought USD/GH¢ call options from KASA Ltd. The table below shows the various spot rates and strike prices for the various tenors.

Month	Spot Rate USD/GH¢	Exercise Rate/Price USD/GH¢
1	5.1	4.8
2	5.3	5.0
3	5.5	5.4
4	5.8	5.8
5	5.7	6.0
6	6.0	6.4

Required:

Determine the intrinsic value of the option for each trading month and clearly indicate the months in which the option is in-the-money, at-the-money, or out-of-the-money. (6 marks)

Answer

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Tags: Currency risk, Hedging, Intrinsic value, Options
Level: Level 2

Topic: Futures and hedging with futures, Hedging with options
Series: NOV 2020

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

Question

Asanka Ghana Ltd is a medium-sized business in Ghana that is currently borrowing GH¢1,000,000 from North East Bank at a floating or variable interest rate basis at Ghana Reference Rate (GRR) plus 3% margin which is market determined on a monthly basis. This makes their monthly interest payment volatile depending on where GRR is at the end of the month. They are rather interested in fixed interest payment at the end of the month to manage this volatility.

OTI Bank Ghana Ltd has agreed to do an Interest rate Swap with Asanka where OTI Bank Ghana Ltd pays the variable rate to Asanka but Asanka pays them a fixed rate of 21% per annum paid monthly.

The table below shows the GRR for the last 6 months:

Month	GRR (%)	Fixed Rate (D)
1	16%	21%
2	18%	21%
3	20%	21%
4	19%	21%
5	18%	21%
6	17%	21%

Required:

i) Calculate the variable interest, fixed interest, and net settlement under columns (C), (E), and (F) in the table above.
(8 marks)

ii) Will you describe this strategy as an interest rate hedge? Explain.
(2 marks)

Answer

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Tags: Financial risk management, Hedging, Interest rate hedge, Interest rate swaps, Swaps
Level: Level 2

Topic: Hedging with options
Series: MAY 2020

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

Question

a) AD Ventures imports tomato paste from Italy for sale in Ghana. AD Ventures typically buys the tomato paste on an open account and pays the euro invoice value two months after receipt of goods. AD Ventures has suffered heavy exchange rate losses of late due to the continuous depreciation of the Ghanaian cedi against the euro. AD Ventures will receive a consignment of tomato paste on 15th May 2016. The value of this consignment is EUR540,000, which must be settled in two months’ time (settlement deadline being 15th July 2016).

The current spot exchange rate for the euro is GH¢4.7110/EUR. Financial pundits forecast that the Ghanaian cedi will depreciate against the euro in the coming months. The owner-manager of AD Venture, Akua Donkor, is worried about the probable foreign exchange loss her business may suffer when the invoice value is settled in two months’ time.

Akua Donkor has heard of the possibility of hedging AD Ventures’ currency exposure with a forward contract or futures contract but does not know what these contracts are. She has asked you to advise her on what to do to hedge against the underlying exposure relating to the EUR540,000 tomato paste consignment.

You would like to recommend a futures market hedge to Akua Donkor. You searched the derivatives market; and you found a futures contract on the euro that matures in August 2016. Other relevant details of the contract follow:

Contract size: EUR100,000
Futures contract price: GH¢4.8112/EUR

Required:
i) Explain to Akua Donkor FOUR differences between a forward contract and a futures contract. (4 marks)
ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AD Ventures facing in relation to the EUR540,000 tomato paste consignment? Explain why. (4 marks)
iii) Explain to Akua Donkor THREE disadvantages of hedging the euro exposure with a futures hedge. (6 marks)

b) It has been observed that interest rates on debt securities or loans differ for different maturities. For the week ending 28th August 2015, the annual interest rate on the 1-year Government of Ghana note was 22.5% whereas the annual interest rate on the 2-year note was 23%.

Required:
With THREE reasons, explain why interest rates on debt securities and loans are different for different maturity periods. (6 marks)

Answer

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Tags: Currency risk, Forward Contracts, Futures Contracts, Hedging, Interest Rate
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2016

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

Question

a) The Treasury Department of LCM Ltd is preparing financial plans for the ensuing financial year. Annual credit sales revenue is projected to be GH¢500 million while the cost of sales is expected to be GH¢260 million. Its current assets are composed of inventory and trade receivables, while its current liabilities comprise trade payables and bank overdraft. The following targets have been set:

Receivables turnover days: 90 days
Payables turnover days: 30 days
Operating cycle: 150 days
Current ratio: 1.1 times

The company’s long-term capital consists only of owners’ equity. The composition and size of long-term capital are expected to remain the same for the ensuing year. The opportunity cost of equity capital is 20%, and the interest rate on the bank overdraft is 18%.

Required:
i) Compute the amount of bank overdraft the company will need in the ensuing year. (6 marks)
ii) Compute the net working capital of the company for the ensuing financial year. (2 marks)
iii) Compute the cost of financing working capital (in GH¢). (3 marks)
iv) Identify the working capital financing policy LCM Ltd is employing. (4 marks)

b) Risk can be hedged through a variety of derivative instruments such as futures, options, and swaps. Each derivative instrument presents its advantages and disadvantages.

Required:
In reference to the above statement, justify why a company would choose a currency futures contract over a currency option contract in hedging currency exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Futures, Currency options, Financing policy, Payables turnover, Receivables turnover, Working Capital
Level: Level 2

Topic: Hedging with options, Working Capital Management
Series: JULY 2023

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)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk, Hedging, Options, Profit and loss calculation
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2019

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

Question

i) Explain the term intrinsic value of an option. (1 mark)

ii) DUU Ghana Ltd bought USD/GH¢ call options from KASA Ltd. The table below shows the various spot rates and strike prices for the various tenors.

Month	Spot Rate USD/GH¢	Exercise Rate/Price USD/GH¢
1	5.1	4.8
2	5.3	5.0
3	5.5	5.4
4	5.8	5.8
5	5.7	6.0
6	6.0	6.4

Required:

Determine the intrinsic value of the option for each trading month and clearly indicate the months in which the option is in-the-money, at-the-money, or out-of-the-money. (6 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk, Hedging, Intrinsic value, Options
Level: Level 2

Topic: Futures and hedging with futures, Hedging with options
Series: NOV 2020

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

Question

OTI Bank Ghana Ltd has agreed to do an Interest rate Swap with Asanka where OTI Bank Ghana Ltd pays the variable rate to Asanka but Asanka pays them a fixed rate of 21% per annum paid monthly.

The table below shows the GRR for the last 6 months:

Month	GRR (%)	Fixed Rate (D)
1	16%	21%
2	18%	21%
3	20%	21%
4	19%	21%
5	18%	21%
6	17%	21%

Required:

i) Calculate the variable interest, fixed interest, and net settlement under columns (C), (E), and (F) in the table above.
(8 marks)

ii) Will you describe this strategy as an interest rate hedge? Explain.
(2 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Financial risk management, Hedging, Interest rate hedge, Interest rate swaps, Swaps
Level: Level 2

Topic: Hedging with options
Series: MAY 2020

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

Question

Contract size: EUR100,000
Futures contract price: GH¢4.8112/EUR

Required:
With THREE reasons, explain why interest rates on debt securities and loans are different for different maturity periods. (6 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk, Forward Contracts, Futures Contracts, Hedging, Interest Rate
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2016

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

Question

Receivables turnover days: 90 days
Payables turnover days: 30 days
Operating cycle: 150 days
Current ratio: 1.1 times

b) Risk can be hedged through a variety of derivative instruments such as futures, options, and swaps. Each derivative instrument presents its advantages and disadvantages.

Required:
In reference to the above statement, justify why a company would choose a currency futures contract over a currency option contract in hedging currency exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Futures, Currency options, Financing policy, Payables turnover, Receivables turnover, Working Capital
Level: Level 2

Topic: Hedging with options, Working Capital Management
Series: JULY 2023

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

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)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk, Hedging, Options, Profit and loss calculation
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2019

Topic: Hedging with options

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FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

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.

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

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.

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FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

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FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

You're reporting an error for "FM – May 2020 – L2 – Q3b – Hedging with options"

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

You're reporting an error for "FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options"

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

You're reporting an error for "FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management"

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.

You're reporting an error for "FM – MAY 2019 – L2 – Q3b – Foreign exchange risk and currency risk management | Hedging with options"

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

You're reporting an error for "FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options"

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

You're reporting an error for "FM – May 2020 – L2 – Q3b – Hedging with options"

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

You're reporting an error for "FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options"

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

You're reporting an error for "FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management"

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.

You're reporting an error for "FM – MAY 2019 – L2 – Q3b – Foreign exchange risk and currency risk management | Hedging with options"

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