A company called Worldwide Development Ltd from Europe, had an electronic software manufacturing plant built for...

A company called Worldwide Development Ltd from Europe, had an electronic software manufacturing plant built for them by Electronic Merchandise Ltd, a company from the United States of America (USA). The amount that Worldwide Development Ltd owes to Electronic Merchandise Ltd for the manufacturing plant is $10,000,000. Worldwide Development Ltd Electronic agreed to pay Electronic Merchandise Ltd six months from now for the manufacturing plant. The current spot rate is €0.8573/$, the three month forward rate is €0.8617/$ and the six month forward rate is €0.8650/$. The annual interest rate is 0.2% in the USA and 2.0% in Europe. Electronic Merchandise Ltd can buy a six-month call or put option on $ at the strike price of €0.8649/$. The premium for put and call options are the same, namely €0.03 per $.

i. Should Electronic Merchandise Ltd enter into a put or call option? (Specify put or call and on what currency in the space provided below.)

ii. Compute the expected total future dollar cost (premium plus strike) of meeting this obligation if the option hedge is entered into by Electronic Merchandise Ltd. Show your workings and the correct answer as follows in the space provided below:

Premium:

Strike price:

Total cost:

One of the following answers will be correct for the total future dollar cost:

a. € 8,952,000.00

b. € 8,949,300.00

c. € 11,865,030.29

d. € 11,862,330.29

Solutions

Expert Solution

i. Should Electronic Merchandise Ltd enter into a put or call option? (Specify put or call and on what currency in the space provided below.)

The electronic merchandise need $ after 6 months which means the company has to buy call option to get a right to buy dollar

Premium: Premium per dollar * number of dollars = 0.03 * 10000000 = 300000 Euros

Strike price: Strike price * number of dollars = 0.8649 * 10000000 = 8649000 Euro

Total cost: Euro Premium + Interest cost on premium + strike price = 300000 + 300000 *2%/2 + 8649000 = 8949300 Euros

One of the following answers will be correct for the total future dollar cost:

b. € 8,949,300.00

Please upvote if answer is correct

jeff jeffy answered 1 year ago

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