Comparison of Hedging Techniques
Response to the following problem:
You own a U.S. exporting firm and will receive 10 million Swiss francs in 1 year. Assume that interest parity exists. Assume zero transaction costs. Today, the 1-year interest rate in the United States is 7 percent, and the 1-year interest rate in Switzerland is 9 percent. You believe that today's spot rate of the Swiss franc (which is $.85) is the best predictor of the spot rate 1 year from now.
You consider these alternatives:
¦ hedge with 1-year forward contract,
¦ hedge with a money market hedge,
¦ hedge with at-the-money put options on Swiss francs with a 1-year expiration date, or
¦ remain unhedged. Which alternative will generate the highest expected amount of dollars? If multiple alternatives are tied for generating the highest expected amount of dollars, list each of them.