XYZ Ltd. an Indian firm needs to pay JAPANESE YEN (JY) 1 crore on 30th June. In order to hedge the risk involved in foreign currency transaction,…

CA Final · Advanced Financial Management · MTP · May 2024
XYZ Ltd. an Indian firm needs to pay JAPANESE YEN (JY) 1 crore on 30th June. In order to hedge the risk involved in foreign currency transaction, the firm is considering two alternative methods i.e. forward market cover and currency option contract. On 1st April, following quotations (JY/INR) are made available: Spot: 1.7825/1.82453 months forward: 1.8726/1.8923 The prices for forex currency option on purchase are as follows: Strike Price: JY 1.8855Call option (June): JY 0.047Put option (June): JY 0.098 For excess or balance of JY covered, the firm would use forward rate as future spot rate. You are required to recommend cheaper hedging alternative for XYZ LTD. Note: Except rates round off other calculations to nearest rupees.

Suggested Answer and Working Notes:

(i) Forward Cover 3-month Forward Rate = 1 / 1.8726 = 0.5340/JY Accordingly, INR required for JY 1,00,00,000 (1,00,00,000 X 0.5340) = 53,40,000 (ii) Option Cover To purchase JY 1,00,00,000, XYZ LTD shall enter into a Put Option @ JY 1.8855/INR Accordingly, outflow in INR = JY 1,00,00,000 / 1.8855 = 53,03,633 Premium = (INR 5303633 × 0.098) / 1.7825 = 2,91,588 Total Outflow = 53,03,633 +2,91,588 = 55,95,221 Since outflow of cash is least in case of Forward Cover, same should be opted for.

Topics: Foreign Exchange Exposure and Risk Management

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