Dozier: Options

1555 WordsJun 15, 20127 Pages
Dozier Since the acceptance of Dozier Industries’ bid, the company CFO has been exploring the methods available to best manage the exchange risk associated with the award payment being dispersed in British Pounds (GBP). He originally considered a forward contract or a spot contract, but is now investigating how currency options could help hedge against uncertain foreign exchange exposure. The CFO needs to decide whether or not options contracts might provide some benefit to hedge the currency risk. As of 1/14/86, Dozier has received a 10% deposit of the total contract value of £1,175,000.00. At the 1/13/86 exchange rate, this value translates to $170,140.00. The remaining £1,057,500.00 is a receivable that Dozier currently holds and…show more content…
(Refer to Exhibit A for graphical representation of this strategy.) We believe that this hedge strategy would be an effective way for Dozier to guarantee themselves a range of possible profits. It would not allow them to reach their desired 6% profit margin; however they would be guaranteed to at least make 1.433% and could very well make more on this project. There is however a large catch; these options expire in March and we will not be paid our receivable until 4/13/86. That means as soon as these options expire Dozier effectively has no hedge on the receivable for a month. They would be exposed to the same currency risk of the exchange rate decreasing as before they implemented the options hedge. In reality this hedge would be very ineffective. However, if we were given quotes on options that expired in April, we could create a very similar strategy just with different prices for the corresponding puts and calls. This would still result in a similar guaranteed profit range. As seen in Dozier Industries (A), the forward hedge yields a profit of $28,795.50. Using our option-based hedge described above we can produce the same profit at an exchange rate of approximately $1.455/£. This was calculated using the following formula: Remaining GBP to exchange at FX rate (x) + 10% deposit already exchanged + Income from selling calls - Cost of purchasing puts - Project cost = Desired profit £ 1,057,500(x) + $170,140 + $9,562.50 - $46,750
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