Too Many Derivatives from Which to Choose?
A bookseller has long done business only within the United States. Recently its managers have decided to branch out. The company now has branches in Southeast Asia, the Middle East, and South America.
A consequence is that the firm is now exposed to foreign exchange risks. It does business with two banks, which offer to provide hedging services for the firm using currency futures contacts and options contracts. Both banks, however, have just announced significant increases in their fees for providing these services.
For this reason, the company’s upper management is contemplating limiting their hedging actives to only one of the two currently used hedging methods.
1. What issues do this firm’s managers face as they consider the choice between options and futures?
2. Under what circumstances would one hedge with options? Under what circumstances would one hedge with futures? What are the advantages and disadvantages of each hedging alternative?
3. Since the firm is using hedging to manage exchange rate risk, should the firm manage the hedging in-house, or should the firm agree to the higher fees and have the banks continue to manage the hedging activities?
Case Studies follow the following general format:
•An Introduction where you explain the situation and the decision(s) facing the firm. Most, if not all, of this information will be in the case.
•Alternatives: here you define terms as needed and identify the alternative available to the firm.
•Evaluate the alternatives: discuss the advantages and disadvantages of each of the relevant alternatives.
•Recommendation and conclusion: select one of the alternatives as your recommendation. Support your recommendation with information used in your case analysis.
Provide specific and detailed recommendations.
•Use additional resources as needed, but remember to cite and reference them properly using APA style.