Case Study:

Currency Risk Management

Using Option Contract
Mr. X is the financial manager of XYZ Company Ltd., which deals
in FOREX trading. The company is doing well and the volume of
transactions is up to the target. It is starting a new policy to attract
the corporate treasurer and other financial executives to invest in
risk-free option trading. Mr. X has been assigned the task of
meeting the prospective investor and explaining the company’s risk
management policy, features of options, and benefits of trading in
options to them. He has to convince the investors about the
advantages and uniqueness of trading in FOREX, especially in
option contracts.

As a representative of the company, he suggests to the client how

an option can be profitably used for hedging FOREX currency risk.
The trading environment is very favorable and the government has
recently announced liberal policies to encourage individual
investors to participate in the financial market. Assume that the
SENSEZ has already attained 19000and is expected to move up in
near future.
 Questions:
Q1: Which type of option would suit the investors the most in the current situation
and why?

Ans. In the current market situation, where the SENSEX has already attained 19000,
the company should suggest that investors invest in futures options. It carries
maximum risk exposure and also provides freedom to the investor to settle the
contract any time before the maturity period.

Q2. How is the option contract better than other financial derivatives?

Ans. The option contract has competitive advantages over other financial derivatives,
for the following reasons:
• It provides the freedom to exercise the option without any obligation.
• It provides an opportunity to generate profits by speculating on the foreign
exchange market without taking too much risk.
• It protects the investors from the volatility of the exchange rate.
• It provides easy accessibility and flexibility to the investors.