Question

Kemper Corp is certain that the British pound will depreciate substantially over time. It has 3 million pounds as receivables due in 60 days, If Kemper is correct, the ideal strategy is to:?

?purchase pound currency call options.

?purchase pounds forward.

?sell pounds forward.

none of the options listed

?purchase pound currency put options.

Answer 1

Assuming that Kemper corps is an US co., it has got $3million receivable in 60 days. Thus it is afraid of GBP falling against USD.

There are two sentiments involved. Firstly that GBP will fall but will not fall substantially. In that case, selling GBP forward is a viable option. Second sentiment involved is that GBP will fall substantially. In that case, Kemper should purchase GBP put option.

Explanation: A Put option signifies a right to sell or can be thought as the purchaser of the option’s bet that the price of the underlying will fall. In the present case, Kemper thinks that the GBP will fall against $. Thus, in one way it is betting that GBP will fall.

Further, in case of purchase of any kind of options payment of initial premium money is involved. Thus, to have a positive payout from the transaction the GBP must fall by an amount more than the initial margin. Otherwise, small fall will render an inflow but will be cancelled out by the premium outflow. Thus, on a substantial fall of GBP, Kemper Corp shall sell GBP at strike price and enjoy the difference between Strike price and price after 60 days reduced by the initial premium paid.

Thus Kemper corp must purchase Pound currency put option.