1.If Blades uses call option to hedge its yen payables, should it use the call optionwith the exercise price of $.00756 or the call option with the exercise price of$.00792? Describe the tradeoff.BackgroundOptions are a type of derivative security. They are a derivative because the price of anoption is intrinsically linked to the price of something else. It is a contract which gives thebuyer (the owner or holder of the option) the right, but not the obligation, to buy or sell anunderlyingasset or instrument at a specific strike price on a specified date, depending onthe form of the option. The right to buy is called a call option and the right to sell is a putoption. People somewhat familiar with derivatives may not see an obvious differencebetween this definition and what a future or forward contract does. The answer is thatfutures or forwards confer both the right and obligation to buy or sell at some point in thefuture. For example, somebody short a futures contract for cattle is obliged to deliverphysical cows to a buyer unless they close out their positions before expiration. An optionscontract does not carry the same obligation, which is precisely why it is called an “option.” Call options give the option to buy at certain price, so the buyer would want the stock to goup. The buyer believes that the underlying stock will rise; if this happens, the buyer will beable to acquire the stock for a lower price and then sell it for a profit. However, if theunderlying stock does not close above the strike price on the expiration date, the optionbuyer would lose the premium paid for the call option. Conversely, the option writer needsto provide the underlying shares in the event that the stock's market price exceeds thestrike due to the contractual obligation. An option writer who sells a call option believesthat the underlying stock's price will drop relative to the option's strike price during the lifeof the option, as that is how he will reap maximum profit.Problem StatementIn our case study, Blades Inc. have to order from Japanese supplier and they have to pay12.5 million. They also want to hedge their payables. We have to determine if they use calloption to hedge yen payables should they exercise call option at an exercise price of$0.00756 or $0.00792.Problem SolutionCall option is one of the most important financial instrument for Multinational companies.Call option gives the company the opportunity to hedge from the exchange rate risk. Calloption gives the buyer a right to buy an underlying asset at a specific price on a specificdate. There are three position a call option can be in- in the money, at the money and outthe money. When spot price/market price is greater than the strike price the call option is inthe money. When spot price is equal to strike price it is at the money and when spot price isless than strike price it is out the money. Page | 1

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