Question

An importer of Swiss watches has an account payable of CHF750,000 due in 90 days. The following data is available:

Rates and prices in US-cents/CHF.

              Spot rate: 71.42 cents/CHF

90-day forward rate: 71.14 cents/CHF

US –dollar 90-day interest rate: 3.75% per year

Swiss franc 90-day interest rate: 5.33% per year

Option Data in cents/CHF

_______________________________                        

Strike                     Call                  Put

70                          2.55                1.42

72                          1.55                2.40

_______________________________

1. Assess the USD cost to the importer in 90 days if it uses a call option to hedge its CHF750,000 account payable. Use the call with a strike price of 72 cents/CHF and include the option call premium in the cost.

2. What will be the cost of the payable in 90 days if a forward contract is used?

c. By how much must the CHF weaken relative to the USD, from 71.42 cents/CHF before the call option provides a lower cost than the forward hedge?

Please show all calculations step-by-step and in detail. Please show parts a, b, and c.

Answer 1

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Answer:

a) From the given data we find the payable amount as = CHF 750000

There is a risk for the importer of CHF currency appreciating against US dollars

For hedging the risk there are two options

selling the call option Strike 72 price @ 1.55 for 90 days contract.

Or

Buying a put option strike of 72 price @ 2.40 for 90 days contract.

If the call option is taken then for hedging the computation is

Lots required for hedging = 750000/1000 = 750 Lots.

Since he is selling a call option, being a seller he will receive the premium = 1.55 *750*1000 = 1162500

2)

Hedging the position using forward contract:

as discussed in part (a) He need sto sell 750 lots of forward contract

Given from the data 90 days Forward Rate = 71.14 cents/CHF

Importer need to sell forward contract for that amount need to be paid = 750*71.14*1000 = 53355000

c)

Given the interest rate for two currencies USD 3.75% and CHF 5.33% per annum

We use interest rate parity to compute forward price

Where

F = 71.42* ((1+0.0375*3/4)/(1+0.0533*3/4))=70.61

The CHF can thus weaken to 71.42-70.61=0.81 cents