General Securities Representative (Series 7) Practice Exam

How can a businessperson hedge against a payment in US dollars due in 30-60 days?

1. Buy futures on US dollars

2. Buy puts on the US dollar

3. Buy calls on the foreign currency

4. Invest in US Treasury Bonds

The correct answer is: Buy calls on the foreign currency

When a businessperson anticipates a payment in US dollars due in 30-60 days, hedging against potential fluctuations in the currency can be essential to protecting profit margins. Buying calls on the foreign currency is a strategic approach because it gives the buyer the right, but not the obligation, to purchase the foreign currency at a predetermined price within a specific timeframe. This means that if the value of the foreign currency increases relative to the US dollar, the businessperson can execute the option and obtain the currency at the lower predetermined price, effectively mitigating the risk of paying more for the currency later. This strategy is particularly relevant when a business has an obligation to make future payments in US dollars but is expecting adverse movements in exchange rates. By purchasing call options, the business can secure favorable terms, even if the market value of the foreign currency rises before the payment is due. The other options, while they may seem relevant at first glance, do not provide the same direct protection against currency movements in this context. Thus, selecting to buy calls on the foreign currency is a proactive and effective method for hedging against the potential challenges associated with fluctuating foreign exchange rates.