Question

In: Finance

Your company (US-based organization) is expected to receive 4 million British pounds in nine months. You...

Your company (US-based organization) is expected to receive 4 million British pounds in nine months. You decide to use European call options to fully hedge against your currency risk. Each call option has 500,000 pounds attached and has an exercise price and premium of $1.25/pound and $.75/pound, respectively. The spot price for pounds the day that you established your hedge was $1.2/pound.

Find the exercise value (in dollars) of the call options on the day you created your hedge. Round intermediate steps and your final answer to four decimals.

Find the time value (in dollars) of the call options on the day you created your hedge.  

  • .75
  • 0
  • 1.25
  • .5
  • .05

Find your profit/loss (in dollars) from your options if the dollar/pound spot price is $1.3/pound when the options expire.

  • $3 million
  • -$2.8 million
  • $2.8 million
  • -$3 million

Find your profit/loss (in dollars) from your options if the dollar/pound spot price is $1.1/pound when the options expire.

  • -$3.6 million
  • $3.6 million
  • -$3 million
  • $3 million

Solutions

Expert Solution

Excercise price per pound=   $1.25  
Premium paid per pound=   $0.75  


Value of call option = Spot price on Expirtaion - Excercise price      
Net profit or loss = Value of option -Premium paid      


If stock price is less than Excercise price, option will not be excercised by Speculator. Value shall be nil. in this case loss will be equal to premium paid. In other situation when Stock price is more than Excercise price, profit shall be calculated by above formula.      
      
(a) Value of option       
Spot price per pound is $1.2 on the date of hedge      
Spot price is less than Excercise price. So.option will not be excercised. So intrinsic value is nil       


Time value= Premium paid - Value of option      
0.75-0=   $0.75  
So time value is   $0.75  
      
(b) Dollaro pound spot price =   $1.30  


So Value per option= 1.30-1.25=   $0.05  


Net profit or loss = 0.05-0.75=   -$0.70  


Size of Contract=   500000   pounds
Pounds hedged=   4000000  
No of contracts purchased= 4000000/500000=   8  
      
Total profit or loss = Profit per option*No of contract*Contract size      
-0.70*8*50000=   -$2,800,000.00  


So loss is -$2.8 millions      


(c) Dollar pound spot price=    $1.10  
value per option will be nil. As Spot price is less than Excercise price, option will not be excercised      


Net profit or loss = 0-0.75=   -$0.75  
Total profit or loss = Profit per option*No of contract*Contract size      
-0.75*8*500000=   -$3,000,000.00  
      
So loss on option is -$3 millions      


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