Question

Alpaca corp. will pay 460,000 pounds (GBP) in 90 days. The current spot rate is USD 1.4883/GBP. The 90-day European call options on the pound with an exercise price of USD 1.6688/GBP are traded with a premium of USD 0.17 while the 90-day European put options on the pound with an exercise price of USD 1.7483/GBP are traded with a premium of USD 0.13. Suppose, Alpaca corp. wants to hedge its position using options. If the spot rate in 90 days is USD 1.8154/GBP, determine the company’s net payment in USD if it acts rationally.

Select one:

a. 894,884

b. 845,848

c. 835,084

d. 767,648

Answer 1

Answer: Option (b) 845,848

90-Day	Exercise Price	Premium
Call	USD 1.6688/GBP	USD 0.17
Put	USD 1.7483/GBP	USD 0.13

	Amount Payable in 90 Days = 460,000 GBP
	Current Spot Rate    = USD 1.4883/GBP
	spot rate in 90 days = USD 1.8154/GBP
	If the Company acts rationally, as it has a Payable in foreign Currency after 90 Days,
	It should enter into a Call Option to protect againsts its exchange rate Exposure.
A	Call Option Premium Payable = GBP460,000 * USD 0.17/GBP
	Call Option Premium Payable = USD 78,200
B	On payment of Specified Premium, Call Option gives the Option holder Right to Buy at the Specified Exercise Price if the Actual Spot Price on the Date of expiry goes above the Exercise Price.
	As the Spot Price after 90 Days is higherthan the Exeercise Price of the Call Option, the Maximum Price Payable for required GBP will be limited to Exercise Price, i.e., USD 1.7483/GBP
	Amount Payable after 90 Days = GBP 460,000 * USD 1.6688/GBP
	Amount Payable after 90 Days = USD 767,648
C	Company’s net payment in USD if it acts rationally = USD 78,200 + 767,648
	Company’s net payment in USD if it acts rationally = USD 845,848