Portfolio value: €15 million. Expected 12-month return: 26%. Current exchange rate: $1.56 per euro. Expected exchange rate in 12 months: $1.51 per euro. Euro put premium: $0.065. Delta: -0.58. Assuming currency fluctuation and return expectations prove accurate and the price of a put option rises by $0.036 over the next 12 months, how many put options must Bender buy or sell a year from now to hedge the position? A) Buy 387,931 options. B) Buy 6,724,138 options. C) Sell 5,028,736 options.
and please show some working!
doesnt tell you how many shares??
C Original shares 15MM/.58=25862068 puts new delta =p1-p0/x1-x0 .036/1.56-.151=.72 15MM/.72=20833333 puts needs 25862068-20833333=5028756
why would you be selling puts not buying puts?
here is the answer. ------- The correct answer was A. To create the currency delta hedge, Bender must purchase the following put options: −1 / delta × portfolio value = 25,862,069 contracts. Then we must calculate how many options to buy or sell a year from now. New delta = change in put option value / change in exchange rate = ($0.036) / (−$0.05) = −0.72. −1 / delta × portfolio value = number of options contracts needed to hedge. −1 / −0.72 × €15,000,000 × 1.26 = 26,250,000 contracts, or 387,931 more than the current holdings.
don’t like the question
i didn’t think it was bad - the part I excluded was the 1.26 in finding the second delta hedge component, which I have not seen before
not sure that is right, unless someone can explain why we would take the inverse of the delta, instead of just using the recalculated delta.
Wa_Wa Wrote: ------------------------------------------------------- > i didn’t think it was bad - the part I excluded > was the 1.26 in finding the second delta hedge > component, which I have not seen before I don’t like how the new delta was estimated.
I agree with the calculation of initial puts and new delta position, but if you are hedging the position a year from now and we are told to assume that the expected return of the portfolio actually came to fruition, then why are we not using a new port value of 15mm*1.26 = 18.9mm, then buying puts to hedge that amount?
yeah why not hedge the whole thing? is it to do with the hedge the principal only concept?
don’t think it’s a good question.
inputs are making the whole thing confusing but this is a type of question you don’t wanna see but will probably be tested on the exam
answer = more or less what i thought… the 26% is so prominent. thought you had to use it. so that’s fine but shouldn’t the new delta ratio be based on small price movements i.e. a marginal ratio, NOT huge price movements … remember thinking this from text too though anyway, OP, thanks for posting!