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Hedging Strategies for Blade Inc using derivative products

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I have attached a file with the case study for blades inc. as a adobe reader pdf file. It is located on pages 150-151. Below is a copy and paste of it however the table didn't copy and paste so you will need to look at the pdf file. Briefly summarize the case formulate answers to questions 1, 2, 3, 4, 5, and 6 at the conclusion of the case

QUESTIONS

1 If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0.00756 or the call option with the exercise price of $0.00792? Describe the tradeoff.
2 Should Blades allow its yen position to be un-hedged? Describe the tradeoff.
3 Assume there are speculators who attempt to capi-talize on their expectation of the yen's movement over the two months between the order and deliv-erydatesbyeitherbuyingorsellingyenfuturesnow and buying or selling yen at the future spot rate. Given this information, what is the expectation on the order date of the yen spot rate by the delivery date? (Your answer should consist of one number.)
4 Assume that the firm shares the market consensus of the future yen spot rate. Given this expectation and given that the firm makes a decision (i.e., op-tion, futures contract, remain unhedged) purely on a cost basis, what would be its optimal choice?
5 Will the choice you made as to the optimal hedging strategy in question 4 definitely turn out to be the lowest-cost alternative in terms of actual costs in-curred? Why or why not?
6 Now assume that you have determined that the his-torical standard deviation of the yen is about $0.0005. Based on your assessment, you believe it is highly unlikely that the future spot rate will be more than two standard deviations above the ex-pected spot rate by the delivery date. Also assume that the futures price remains at its current level of $0.006912. Based on this expectation of the future spot rate, what is the optimal hedge for the firm?

BLADES, INC. CASE Use of Currency Derivative Instruments
Blades, Inc., needs to order supplies two months ahead of the delivery date. It is considering an order from a Japanese supplier that requires a payment of 12.5 mil-lion yen payable as of the delivery date. Blades has two choices:
Purchase two call options contracts (since each op-tion contract represents 6,250,000 yen).
Purchase one futures contract (which represents

12.5 million yen).
The futures price on yen has historically exhibited a slight discount from the existing spot rate. However, the firm would like to use currency options to hedge payables in Japanese yen for transactions two months in advance. Blades would prefer hedging its yen payable position because it is uncomfortable leaving the posi-tion open given the historical volatility of the yen. Nevertheless, the firm would be willing to remain un-hedged if the yen becomes more stable someday.
International Financial Management, 8th Copyright 2006 Thomson/South-Western C H A P T E R 5 ? C U R R E N C Y D E R I VAT I V E S 151
Ben Holt, Blades' chief financial officer (CFO), prefers the flexibility that options offer over forward contracts or futures contracts because he can let the op-tions expire if the yen depreciates. He would like to use an exercise price that is about 5 percent above the ex-isting spot rate to ensure that Blades will have to pay no more than 5 percent above the existing spot rate for a transaction two months beyond its order date, as long as the option premium is no more than 1.6 percent of the price it would have to pay per unit when exercising the option.
In general, options on the yen have required a pre-mium of about 1.5 percent of the total transaction amount that would be paid if the option is exercised. For example, recently the yen spot rate was $0.0072, and the firm purchased a call option with an exer-cise price of $0.00756, which is 5 percent above the existing spot rate. The premium for this option was $0.0001134, which is 1.5 percent of the price to be paid per yen if the option is exercised.
A recent event caused more uncertainty about the yen's future value, although it did not affect the spot rate or the forward or futures rate of the yen.
Before After Event Event Spot rate $.0072 $.0072 $.0072 Option Information: Exercise price ($) $.00756 $.00756 $.00792 Exercise price (% above spot) 5% 5% 10% Option premium per yen ($) $.0001134 $.0001512 $.0001134 Option premium (% of exercise price) 1.5% 2.0% 1.5% Total premium ($) $1,417.50 $1,890.00 $1,417.50 Amount paid for yen if option is exercised (not including premium) $94,500 $94,500 $99,000 Futures Contract Information: Futures price $.006912 $.006912
Specifically, the yen's spot rate was still $0.0072, but the option premium for a call option with an exercise price of $0.00756 was now $0.0001512. An alternative call option is available with an expiration date of two months from now; it has a premium of $0.0001134 (which is the size of the premium that would have ex-isted for the option desired before the event), but it is for a call option with an exercise price of $.00792.
The table below summarizes the option and futures information available to Blades:
As an analyst for Blades, you have been asked to of-fer insight on how to hedge. Use a spreadsheet to sup-port your analysis of questions 4 and 6.

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Solution Preview

See the attached file for complete solution. The text here may not be copied exactly as some of the symbols / tables may not print. Thanks

Q1:
It should use the call option with the exeercise price $0.00756. The future price of Yen is expected to be $0.006912 which is much lower than the
exercise price. The interest of the firm is to safeguard against any adverse movement in price and take advantage of price movement in expected direction.
The volatility in the market has increases leading to higher cost of the option.
The total option premium for option with exercise price $0.00756 is $1,890.00
The amount paid for yen if option is exercised $94,500
Maximum amount to be paid when the call option with exercise price $0.00756 $96,390.00

The total option premium for option with exercise price $0.00792 is $1,417.50
The amount paid for yen if option is exercised $99,000
Maximum amount to be paid when the call option with exercise price $0.00756 $100,417.50

Thus by paying an extra amount of $472.50 the firm is able to reduce its maximum exposure by $4,500
Hence it is advisable to buy the option with exercise price $0.00756

Q2
It Blades leaves its position unhedges the company is expose to ...

Solution Summary

Provides a detailed analysis of the case Blades Inc: Use of currency derivative instruments using Excel. The case analysis helps students to understand various derivative instruments such as call options, spot market and future contracts and how these instruments can be used for building hedging strategy for the firm.

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