For the following scenarios, describe a hedging strategy using OPTIONS contracts

Question

For the following scenarios, describe a hedging strategy using OPTIONS contracts. Discuss the reasons for your choice of contract. Using only OPTIONs CONTRACTS.

a) A public utility is concerned about rising costs.

b) A corn farmer fears that this year’s harvest will be at record high levels across the country.

c) A natural gas producer believes there will be excess supply in the market this year.

d) A bank derives all its income from long-term, fixed-rate residential mortgages.

e) A stock mutual fund invests in large, blue-chip stocks and is concerned about a decline in the stock market.

f) A U.S. exporter of construction equipment has agreed to sell some cranes to a German construction firm. The U.S. firm will be paid in euros in three months.

Explanation / Answer

a) A public utility is concerned about rising costs. BUY CALL OPTION so that the costs are fixed

b) A corn farmer fears that this year’s harvest will be at record high levels across the country. BUY PUT OPTION so that selling price of the produce is fixed and would not be affected due to low prices in case of good produce

c) A natural gas producer believes there will be excess supply in the market this year. BUY PUT OPTION so that selling price of the gas is fixed and would not be affected due to low prices in case of excess supply

d) A bank derives all its income from long-term, fixed-rate residential mortgages. BUY PUT on interest rates

e) A stock mutual fund invests in large, blue-chip stocks and is concerned about a decline in the stock market. BUY PUT OPTION so that selling price of the stocks is fixed and would not be affected due to decline in prices

f) A U.S. exporter of construction equipment has agreed to sell some cranes to a German construction firm. The U.S. firm will be paid in euros in three months. US FIRM is concerned about dollars..SO, if euro appreciates US firm would incur loss and hence to offset that, BUY CALL on euro or SELL PUT on dollar

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