You are the treasurer of Montana Corp. and must decide how to hedge (if at all)...

You are the treasurer of Montana Corp. and must decide how to hedge (if at all) future payables of 1 million Japanese yen 90 days from now. Call options are available with a premium of $.0004 per unit and an exercise price of $.01040 per Japanese yen. The forecasted spot rate of the Japanese yen in 90 days is $0.01043 with probability 30%, $0.01042 with probability 25%, $0.01039 with probability 25%, and $0.01038 with probability 20%. What is the probability that the call option will be exercised? What is the estimated dollar cash outflows of currency call hedge? 45%; $10,414 55%; $10,793.5 55%; $10,393.5 45%; $10,814

Expert Solution

Answer to the question is as follows :

1. Amount Payable in JP Yen = 1,000,000 JPY

2. Amount Payable in US Dollar @ $0.0104 / Yen = 1,000,000 x 0.0104 = $ 10,400 3 months from now.

3. Call Option Premium = $ 0.0004 p.u. = $ 1,000,000 x 0.0004 = $ 400 for the entire contract

4. As per table following 4 scenarios arise :

Scenario	Forecasted Spot Rate	Probabilty	Strike Price	Payoff [Higher of (Spot - Strike), 0 ]	Option Value
1	0.01043	30%	0.01040	0.00003	In the money
2	0.01042	25%	0.01040	0.00002	In the money
3	0.01039	25%	0.01040	-	Out of the Money
4	0.01038	20%	0.01040	-	Out of the Money

Hence Probability that call option will be exercised is when it is In the money = 30% + 25% = 55% (Scenario 1 Probability + Scenario 2 Probabilty].

5. Estimated Dollar Cash Outflows of Currency Call Hedge =

Scenario	Forecasted Spot Rate	Probabilty	Strike Price	Payoff [Higher of (Spot - Strike), 0 ]	Dollar Payoff received
1	0.01043	30%	0.0104	0.00003	$ 3,129.00
2	0.01042	25%	0.0104	0.00002	$ 2,605.00
3	0.01039	25%	0.0104	-	$ 2,600.00
4	0.01038	20%	0.0104	-	$ 2,080.00
				Total =	$ 10,414.00

ekkarill92 answered 2 years ago

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