368 Planning and Forecasting
case of asset exposure. With the option contract, a call option is acquired in
the case of liability exposure and a put option in the case of asset exposure.
Some relevant commentary, in relation to the above discussion, on the
effects of hedging with currency options, is provided by the disclosures of Ana-
log Devices Inc.:
When the dollar strengthens significantly against the foreign currencies, the
decline in value of the future currency cash f lows is partially offset by the gains
in value of the purchased currency options designated as hedges. Conversely,
when the dollar weakens, the increase in value of the future foreign-currency
cash f lows is reduced only by the premium paid to acquire the options.^19The Analog commentary highlights the one-directional nature of a hedge
that employs a currency option as opposed to a for ward contract. The corollary
of the decline in the dollar is a weakening of the foreign currency. This is the
unfavorable outcome that the hedge is designed to offset. Indeed, the above
comments indicate that a gain on the option contract is produced to offset the
decline in future cash f lows that result from a strengthening of the dollar.How-
ever, when the dollar instead weakens, there is no offsetting loss, beyond “the
premium paid to acquire the options.” The corollary of the weakening of the
dollar is the strengthening of the foreign currency. A strengthening of the for-
eign currency is not the unfavorable currency movement that the currency
option was intended to protect against.
As with the for ward contracts, a sampling of disclosures by companies
that are using currency options for hedging purposes is provided in Ex-
hibit 12.8. Currency options are used less frequently than for ward contracts.
Most of the options used are over-the-counter (OTC) as opposed to exchange-
traded options. Given the OTC character of these currency options, they share
the tailoring feature of the for ward contracts. That is, unlike exchange traded
options that come in standard amounts of currency and limited maturities,
both for ward contracts and options can be tailored in terms of currency
amount and maturity. However, unlike forward contracts, the currency options
do require an initial investment—the option premium. Little or no initial in-
vestment is required in the case of the forward contract.
For wards and options are the most popular currency derivatives, and it is
very common, as both Exhibits 12.5 and 12.8 reveal, for firms to use both in-
struments. The last currency derivative that is only brief ly reviewed is the
futures contract. The futures contract shares the symmetrical gain and loss
feature of the for ward contract.
Currency Futures
Currency futures are exchange-traded instruments. Entering into a futures
contract requires a margin deposit and a round-trip commission must also be
paid. As is true of exchange-traded currency options, futures contracts come in
fixed currency amounts and for a limited set of maturities. Futures contracts