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

Given data follows belows
A U.S. Company expects to receive amount = 100 million.

Russian Ruble from now = 3 months

Strike price of for each option = RR60 per dollar

Premium of for the call option = 1.5%

Premium of for the put option =  2.3%

WACC for the U.S. Company is =12%.

Current spot rate is = RR58.30 per dollar

a) Calculating 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

Cost of option hedge today

U.S. Company expects to receive amount / Strike price of for each option x Premium of for the put option

= 100,000,000/60)*2.3%

= 1,666,666 x 3.3%

=$38,333

Calculating cost of option hedge

Cost of option hedge today x( 1 +  WACC for the U.S. Company / 4)

= 38333*(1+0.12/4)

= 38333*(4.12/4)

= 38333*1.03

= $39,482.99 or $39,483

b) Calculating company receive (net) in 3 months from the option hedge

Maturity = 1 / 63

=0.01587301587 or 0.0159

Strike price = 1 /60

= 0.01666666667 or 0.0167

Amount receivable per the option

Company expects to receive amount /  Strike price of for each option

  100000000/60 = $ 1,666,667

less option maturity =  $39,483

Net option premimum = $ 1,627,184

(1,666,667 -  $39,483)

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