Question

A U.S. Company expects to receive 100 million Russian Ruble 3 months from now. A call and put on Russian Ruble are available with a strike price of RR60/$ for each option, and a premium of 1.5% for the call option and a premium of 2.3% for the put option. The weighted average cost of capital (WACC) for the U.S. Company is 12% and the current spot rate is RR58.30/$.

a. If the company hedges in the option market, which option will it choose and what is the cost of option hedge today and at maturity in U.S. Dollars? Explain your answer very well

b. If the spot rate at maturity is RR63/$, how much would the company receive (net) in 3 months from the option hedge?

Answer 1

a]	The company should choose the put option as,
	the option will enable the company to sell the
	Russian Ruble on receiving it after 3 month.
	Cost of option hedge today = (100,000,000/60)*2.3% =	$              38,333
	Cost of option hedge at maturity = 38333*(1+0.12/4) =	$              39,483
b]	The quoted rate is an indirect rate. The direct rate for
	Rouble on maturity = 1/63 [$/R]	0.0159
	The strike price for Rouble = 1/60 =	0.0167
	As the strike price for rouble is more, the option would
	be exercised.
	Amount receivable per the option = 100000000/60 =	$ 1,666,667
	Less: The cost of option at maturity	$              39,483
	Receipt net of option premium	$ 1,627,184