Kenneth R. Szulczyk
- Trident Company can buy a 90-day put option for pounds. Put option grants Trident the right
to sell British pounds at the strike price of $1.75 / pound with a premium of 1.5%. On the
other hand, Trident could buy a 90-day call option for U.S. dollars, which would achieve the
same thing. - The Trident Company could borrow funds from a British bank. The 90 - day loan rate in
pounds is 14% Annual Percentage Rate (APR).
Strategy 1: Trident does nothing, and it exchanges funds using the spot exchange rate. If
the exchange rate does not change, then Trident will receive $ 5 .286 million, computed in
Equation 2. Nevertheless, Trident has an exchange rate risk. If the British pounds appreciate,
subsequently, Trident will gain more U.S. dollars. On the other hand, if the British pounds
depreciate, then Trident receives fewer U.S. dollars.
ݐ݊ݑ݉ܽ($)= 3 ݈݈݊݅݅݉ ݏ݀݊ݑ൭$1.^760 ൗ 1 ݀݊ݑ൱=$5. 28 ݈݈݊݅݅݉ (2)
Strategy 2: Trident enters a forward contract. A forward contract is better than a currency
futures because the forward contracts are tailor made for amounts and do not require a margin
call. Consequently, Trident does not have any exchange rate risk because it locked into an
exchange rate today. Trident will receive $5.355 million in 90 days, calculated in Equation 3.
Forward contract is better than the future spot exchange rate.
ݐ݊ݑ݉ܽ($)= 3 ݈݈݊݅݅݉ ݏ݀݊ݑ൭$1.^785 ൗ 1 ݀݊ݑ൱=$5. 355 ݈݈݊݅݅݉ (3)
Strategy 3: Trident buys the put option. It pays a premium, $ 78 , 750 , calculated in Equation
4 and insured its transaction for an exchange rate of $1.75 per pound. Thus, Trident does not
have an exchange rate risk, and the option guarantees at least $5.25 million, computed in
Equation 5. Trident will only exercise the put if the British pounds depreciate, and the exchange
rate falls below $1.75 per pound. Although the put option yields less revenue than the forward,
Trident would buy the put option if it strongly believes the British pound will appreciate. If the
pound does indeed appreciate, subsequently, Trident sells its pounds in the spot exchange
market. However, if the pounds depreciate, then Trident uses the put option to sell its pounds,
preventing a loss.