Option Pricing

Prepare a report (3-5 pages) that discusses derivative financial instruments and evaluates the purchase of a hypothetical currency option.

Introduction

This assessment will allow you to practice two approaches for hedging an exposure to the change in a foreign currency.

Demonstration of Proficiency

By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies through corresponding scoring guide criteria:

  • Competency 1: Apply advanced accounting techniques to organizational situations.
    • Discuss the nature of derivative financial instruments.
    • Indicate the factors that might influence the value of the USD against the Ghanaian Cedi.
    • Explain how much was won or lost by purchasing a 90-day option.
    • Discuss how a defined purchase contract could hedge against a change in exchange rate between the USD and the Ghanaian Cedi.
  • Competency 5: Communicate in a manner that is professional and consistent with expectations for members of the business professions.
    • Communicate in a manner that is professional and consistent with expectations for members of the business professions.

Scenario

Hopkins Chocolate Company buys green cocoa beans that are processed into consumer products. Cocoa beans are currently selling for $2,000 United States Dollars (USD) per metric ton. Hopkins buys 100 tons at a time from Abamo Chocolate in Ghana, Africa. Normal purchase procedures stipulate that the purchase contract is denominated in Ghanaian Cedi and payment in Cedi is due 90 days after purchase.

Recently, the treasurer of Hopkins became concerned that the U.S. Dollar would change in value against the Ghanaian Cedi. Consequently, Hopkins bought a 90-day option.

Your Role

You are the controller for Hopkins Chocolate Company.

Requirements

As the controller of Hopkins Chocolate Company, you work closely with the treasurer. She has requested that you prepare a report to help explain the recent purchase of the 90-day option to members of the board of directors. Address the following in your report (3–5 pages):

  1. Discuss the nature of derivative financial instruments.
  2. Explain the factors that might influence the value of the USD against the Ghanaian Cedi. Discuss at least three factors.
  3. Hopkins bought a 90-day option to exchange $200,000 USD for 900,000 Cedi. They paid $8,000 USD for the option and today it has been 90 days. Locate today’s value of the Cedi at XE.com’s Live Exchange Rates and calculate how much Hopkins won or lost by purchasing the 90-day option. Explain your calculations in detail.
  4. Discuss how Hopkins could use a defined purchase contract to hedge against a change in exchange rate between the USD and the Cedi.

Deliverable Format

Since you plan to share your report with the treasurer and the board of directors, you want this report to be clear, well-organized, and readable. Your supervisor has requested that your report be 3–5 pages so that you have enough space to develop your ideas and provide some scholarly and/or professional context.

  • Communication: Communicate in a manner that is scholarly, professional, and consistent with the needs and expectations of senior corporate leadership and other stakeholders. For this scenario, assume the treasurer and the board of directors expect original work, critical thinking, and scholarly sources. Your writing must be free of errors that detract from the overall message.
  • Your report is a professional document and should therefore follow the corresponding MBA Academic and Professional Document Guidelines, including single-spaced paragraphs.
  • Resources: At least three resources that are scholarly and/or professional. So that your imaginary board of directors can locate more information about derivative instruments and currency options, include a reference page at the end of your report.
  • Report length: Minimum of 3–5 pages, not including reference pages.
  • Font and font size: Times New Roman, 12 pt.

Faculty will use the scoring guide to review your deliverable as if s/he were a director on the board. Review the scoring guide prior to developing and submitting your assessment.

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