Suppose that Bechtel Group wants to hedge a bid on a Japanese construction project. Since the yen exposure is contingent on acceptance of its bid, Bechtel decides to buy aput option for theU15 billion bid amount rather than sell it forward. In order to reduceits hedging cost, however, Bechtel simultaneously sells a call option forU15 billion withthe same strike price. Bechtel reasons that it wants to protect its downside risk onthe contract and is willing to sacrifice the upside potential in order to collect the callpremium.
(a) Diagram Bechtel’s profits/losses on each contract (long put and short call).
(b) Diagram Bechtel’s total profits/losses (both contracts jointly).
(c) Comment on Bechtel’s hedging strategy. Is Bechtel really protecting its downsiderisk? What if Bechtel loses its bid and the yen appreciates?