Forward versus Option Hedge
Response to the following problem:
Assume that interest rate parity exists. Today, the 1-year interest rate in Japan is the same as the 1-year interest rate in the United States. You use the international Fisher effect when forecasting how exchange rates will change over the next year. You will receive Japanese yen in 1 year. You can hedge receivables with a 1-year forward contract on Japanese yen or a 1-year at-the-money put option contract on Japanese yen. If you use a forward hedge, will your expected dollar cash flows in 1 year be higher than, lower than, or the same as if you had used put options? Explain.