|University||Institute of Singapore Chartered Account (ISCA)|
|Subject||RM119 : Treasury Risk Management For The Corporation|
Assignment – Options Pricing (Individual Assignment) For Question 1,
In Question 1, students are expected to research the Swiss National Bank’s intervention in the foreign currency market. In both questions, the emphasis is on analytical thinking to assess the effectiveness and implications of the hedging strategies.
In January 2015, the Swiss National Bank (SNB) suddenly announced that it would no longer hold the Swiss franc at a fixed exchange rate with the euro. The franc was pegged at 1.2 Swiss francs per euro from 2011 to 2015. A day after de-pegging, the franc’s value had soared to just 0.85 francs. Hedge funds across the world made big losses. The Swiss stock market collapsed.
Required: Discuss the reasons for the SNB de-pegging the franc and evaluate the hedging strategies implemented by the Swiss exporters and other domestic firms.
Q1: 800. Question 2 US-based company ABC Co. expects to receive a 50 million euro payment from its various exports one year from now. ABC can use any one of the following strategies to deal with the exchange rate risk.
(i) Unhedged strategy
(ii) Forward hedge strategy
(iii) Money market hedge
(iv) Option hedge
The spot rate of the euro as of today is $1.10 and the 1- year forward rate is $1.13. The annual interest rate in the United States is 5.5% versus an annual interest rate of 2% in the eurozone.
The forward rate quoted to ABC does not necessarily satisfy interest rate parity (perhaps ABC’s bank added in commission costs). Put options on euros are available with an exercise price of $1.11, an expiration date of one year from today, and a premium of $0.06 per unit. Call options on euros are available with an exercise price of $1.15, an expiration date of one year from today, and a premium of $0.08 per unit.
Required: a) Identify the risks of each strategy and estimate the dollar cash flows it will receive as a result of using each strategy. To do so you must consider a number of different exchange rate outcomes at the end of one year ranging from the dollar depreciating to the dollar appreciating against the euro.
b) Explain which hedge you think is optimal for ABC. Word count requirement for Q2: 800.
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