When is it appropriate to use average rate options?
REAL-LIFE PROBLEMS, INNOVATIVE SOLUTIONS
BACKGROUND: Average rate options allow hedgers to match off a recurring exposure in both a cost-effective and efficient manner. However, many hedgers are under the impression that these 'cheaper' options can be used in place of European options. This strategy can be fraught with problems, as the underlying exposure and average payoff do not match. We will use the example of a Canadian corporation buying an average rate versus European CAD put/USD call to illustrate why less is not always better
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