Global Finance 367the account receivable that results when the Euro declines in value and the
gain that results when the Euro increases in value. The behavior of a hedge
using a for ward contract versus an option is summarized in Exhibit 12.7.
The symmetrical behavior of the for ward contract in its hedging applica-
tion is evident in Exhibit 12.7. In each of the four combinations of exposure
and exchange rate movement the gains and losses on the balance sheet expo-
sure are offset in turn by the losses and gains on the for ward contracts. How-
ever, the option contracts produce offsetting gains and losses only in those
cases where the unfavorable exchange rate change takes place.^18 Notice that a
gain is produced on the option contract to offset the loss on the balance sheet
asset exposure when the foreign currency depreciated. Currency depreciation
when the firm has asset exposure is an unfavorable rate movement. In the case
of liability exposure, notice that a gain is produced by the option contact when
the foreign currency appreciated. The corollary of appreciation of the foreign
currency is depreciation of the dollar. This is an unfavorable rate movement
because it causes the dollar value of the liability to increase. In the other two
cases, where the option contracts expire without value, the currency move-
ments are favorable: (a) asset exposure and the foreign currency appreciated
and (b) liability exposure and the foreign currency depreciated.
The positions taken in the for ward and option contracts differ based upon
the nature of the foreign-currency exposure. With the for ward contract, the
foreign currency is purchased in the case of liability exposure and sold in the
EXHIBIT 12.7 Behavior of hedge gains and losses with a forward
versus an option.
Type of Exposure Hedged Derivative Contract
Asset Forward Contract Put Option
Foreign currency appreciates
Gain on asset exposure Loss on the for ward Contract expires with
contract neither gain nor loss; option
holder loses initial option
premium paid
Foreign currency depreciates
Loss on the asset exposure Gain on the for ward Contract expires with a gain
contract
Liability Forward Contract Call Option
Foreign currency appreciates
Loss on the liability Gain on the for ward Contract expires with a gain
exposure contract
Foreign currency depreciates
Gain on the liability Loss on the for ward Contract expires with
exposure contract neither gain nor loss; option
holder loses initial option
premium paid