Diva Shoes Inc. Case Study Solution
Evaluation of Alternatives
Both the alternatives can be evaluate don the basis of whether the contact contains a right or an obligation? What would be the initial fees for getting into the contract? And the most important, what is the premium or loss of the option. All these metrics for both of the alternatives are given in the following table;
Table-1
| Alternative 1: Forward Contract
|
Alternative 2: Put Option
|
|
| Right/Obligation | Obligation | Right |
| Initial Fees | Low | High |
| Premium | 208570 | 11784 |
It can be seen from the above table that the Forward Contract would have a high premium than the Put Option, along with it, it would have low initial cost as compare to put option. However, under forward option the company would have an obligation to sale the Yen at a specified price. The company’s expectations about Yen depreciation may prove to be fail.
Recommendations
On the basis of above evaluation of the situations and bot of the hedge contracts, the company is recommended to consider forward contract for hedging its currency risk. The forward contract has a high premium and a low initial costs as compare to Put Option. Although, it has the risk that whether the expectations of the company about Yen would be proved right or not, but the current situations of returning investors back to the US markets force the company to consider a hedge contract, and the better option for the company is forward contract.
Conclusion
Although, currently Yen is appreciating against USD, but it could be depreciated against USD in near future due to the return of investors back to the US markets. Therefore, the company should consider a hedge contract and the recommended option for the company is forward contract.
Exhibits
Exhibit A: Currency Risk
| Risk Exposure | |
| Expected Revenues in JPY | 1803519043 |
| Current Spot Rate | 89.6 |
| Revenues in US $ | $ 20,128,561 |
| Spot Rate Increased | 95 |
| Revenue in USD | $ 18,984,411 |
| Currency Risk | $ 1,144,150 |
Exhibit B: Forward Option Analysis
| Profit (Loss) on 9/28/1995 | |
| Contract Value | 1803519043 |
| Spot Rate at Maturity | 95.00 |
| Forward Rate 6 months | 91.0216598 |
| Profit (Loss) on 9/28/1995 | 208570 |
Exhibit C: Put Option Analysis (Black Scholes Model)
| Put option Price | 6.53393E-06 |
| Contract value | 1803519043 |
| Put Option Intrinsic Value | -0.001260714 |
| Time Value | 0.001267248 |
| Option Premium | 6.53393E-06 |
| Total Option Premium | 11784 |
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