Hi guys,
need some help with a basic hedging problem problem, would like to hear your opinions on those.
Base Information:
• Lufthansa AG was ordering 20 737 jets for USD 500 mill. in January 1985
• Delivery was projected 12 months from now
• DEM/USD had been steadily increasing since the election of Ronald Reagan in 1980
• DEM/USD = 3.2 in 01/1985 (spot = forward)
§ Hedging Alternatives for Lufthansa:
(1) Remain uncovered
(2) Cover the entire exposure with forward contracts
(3) Cover 50% of the exposure with forward contracts, remainder uncovered
(4) Cover the exposure with FX options
(5) Acquire USD now and hold them in money market account until payment is due
- Questions:
• Under what circumstances is the 50/50 hedge desirable?
• Which alternative will never be chosen if FX volatility is low?
-
Options are considered “cheap” hedging instruments, because the user/buyer pays the premium upfront and then has only payoff upside left. True or False?
-
Adding a knock-in feature to a plain vanilla option will make the option cheaper. True or False?
Thank you very much
G.