In: Finance
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.
Find your profit/loss (in dollars) from your options if the dollar/pound spot price is $1.3/pound when the options expire.
Find your profit/loss (in dollars) from your options if the dollar/pound spot price is $1.1/pound when the options expire.
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