Question

7*.12 points] Biogen expects to receive royalty payments totaling £5 million next month. It is interested in protect ing these receipts against a drop in the value of the pound. It can sell 30-day pound futures (futures contract size of £62,500 ) at a price of $1.6500 per pound or it can buy pound put options with a strike price of $1.6700 at a premium of 4.0 cents per pound. The spot price of the pound is currently $1.6500, and the pound is ex- pected to trade in the range of $1.6250 to S1.7500. Biogen's treasurer believes that the most likely price of the pound in 30 days will be S1.6650. a. How many futures contracts will Biogen need to protect its receipts? How many options contracts? Diagram Biogen's profit and loss range of expected exchange rates. Ignore transaction costs and margins. b. with the put option position and the futures position within its

Answer 1

Royalty Payment = GBP 5 million

1 Future contract size = GBP 62500

Number of future contracts required to hedge = 5000000/62500 = 80 contracts

We are not given option contract size however since they are usually synonymous with future contracts size, we take same value hence 80 put option contracts required.

The diagram is as below - since the firm is receiving GBP, it is hedging against GBP depreciation. The company has fixed its exchange rate in futures by selling at 1.65. Now if the price moves above 1.65 there would be loss on futures contract but the same will be set off from better exchange rate payment on royalty amount conversion and vice versa . For the put option the net price after premium will bt (1.67-0.04) = 1.63 and the company is assured to getting this price. If the exchange rate is above 1.67 the put options will expire worthless and below that they will be exercised such that the final conversion price will be 1.63. The profit and loss on futures and put only is presented below:

Now we look at next part:

The break even point for call buyer is = 1.69 and for call writer is 1.61

The call option buyer is bullish on GBP appreciating and vice versa for the seller. The pay off of the call option is given by :

Buyer = Max (expiry price - strike price - premium, - premium)

Seller = Min (expiry price - strike price + premium, premium)