Question

Costa Cruise Lines (CCL) (a U.S. company based in Miami, FL) purchased a ship from Komatsu Heavy Equipment for ¥700 million – payable in 1 year. The current spot rate is ¥110/$ and the one-year forward rate is ¥108/$. For borrowing (or depositing), the annual interest rate in Japan is 6%. In the United States, the rate is 2%. Yen call and put options, with a 1-year expiration date and an exercise price of $.009 are available. The price (premium) of the call option is $.002 per yen. The price (premium) of the put option is $.001 per yen. * Assume that one year from today, the spot rate for yen is either ¥130/$ or ¥105/$.

* If CCL decides to hedge with options, should they use a call or a put?

* If CCL follows the appropriate options hedging strategy, what is CCL’s net cost (in $US) to purchase the ship if the spot rate is ¥130/$?

* What is the net cost if the spot rate is ¥105/$? (Be sure to include the cost of buying the option in your answer.)

Answer 1

one year from today, the spot rate for yen is either ¥130/$ or ¥105/$.

Answer

1) CCL US company Should pay in Yen, Call Option should be considered

As the Spot rate afterone year is either ¥130/$ or ¥105/$.

So it will give hedge to buy after a year

2) if the spot rate is ¥130/$? Considering call is made

Exchange price in Yen/$= 1 / Exercise Price = 1 /0.009 = Yen 111.11 / Dollar

To note that Exercise price is lesser than Spot rate, so call option will be done

Net Cost = Exercise Price * Yen p + Premium

Net Cost = $0.009 * 700000000 + $0.002 * 700000000

Net Cost when Spot Rate is Yen 130/$= $7700000

3) if the spot rate is ¥105/$ Considering call is made

Exchange price in Yen/$ = 1 / Exercise Price = 1 /0.009 = Yen 111.11 / Dollar

Here exercise price is higher Spot rate, the call option will be lapsed, spot price is applicable

NC = Spot * Yen payable + Premium

Net Cost = 1/105 * 700000000 + $0.002 * 700000000

Net Cost when Spot Rate is Yen 105/$= $8066666.67