Question

In: Finance

The All-Star company borrows funds of USD 1,000,000, with an interest of 5% from Bank of...

The All-Star company borrows funds of USD 1,000,000, with an interest of 5% from Bank of America and has been withdrawn on 15 January 2019.

The loan has a tenor of 1 year. When withdrawing USD/IDR Rp 14,250,-. Currently available Call Options for USD for 365 days tenor are as follows:

Premium 2.5% Strike USD/IDR 16,000, - as of 14 January 2020 If on January 14, 2020, the USD/IDR exchange rate is Rp 15,000,-

A. What is the total cost borne by All-Star on loans from Bank of America?

B. Does All-Star exercise against the Option Call purchased on January 15, 2019?

C. Draw in graphical form for this pay-off Option Call

Expert Solution

To understand this, let us look at how the loan would work without the call option :

The USD loan is converted into IDR at the rate of USD/IDR Rp 14,250
Loan withdrawn in IDR = ($1,000,000 * IDR 14,250) = IDR 14.25 billion
Loan repayment in USD = $1 million + ($1 million + 5%), which is $1.05 million. 5% is the interest rate.
Loan repayment in IDR = ($1.05 million * IDR 15000), which is IDR 15.75 billion

Total Cost borne by All-Star on loans (without call option) is (Loan repayment in IDR - Loan withdrawn in IDR) = IDR 1.5 billion

With the call option,

All-Star would exercise the option if the USD/IDR spot rate on 14/01/2020 is higher than the strike price of IDR 16,000. This way, exercising the call option would result in lower outflow of IDR as the strike price is lower than the spot rate.
Conversely, All-Star would let the option expire worthless if the USD/IDR spot rate on 14/01/2020 is lower than the strike price of IDR 16,000. This way, outflow of IDR is lower than exchanging at the higher strike price of IDR 16,000.

In the example given in the question, All-Star would not exercise the call option as the spot rate on 14/01/2020 is lower than the strike price of the option.

The premium paid on the call option = (Loan in USD * Strike Price of option * 2.5 %). 2.5% is the premium given in the question. premium = $1,000,000 * 16000 * 2.5%, which is IDR 400 million

Total cost borne by All-Star on loans = Total Cost (without call option) + payoff + premium paid

Total cost (without call option) as calculated above is IDR 1.5 billion

payoff is zero as the call option is not exercised

premium paid = IDR 400 million

Total cost borne by All-Star on loans = IDR (1.5 billion + 400 million), which is IDR 1.9 billion

This is the payoff diagram with the X-axis as USD/INR spot rate on 14/01/2020 and Y-axis as option payoff on expiry

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