Question

4. Caltex, an Australian company, is importing some machinery from Germany, and is expected to pay 100m EUR in one year. Spot rate of the EUR/AUD is 1.58. Call option rate on EUR/AUD with delivery in one year is 1.61 with premium of AUD 0.01. In order to hedge its position, Caltex decided to buy the call option. One year later, if the spot rate of the EUR/AUD is 1.60. What is the total amount that Caltex will pay in AUD?

5. Apple Inc. is expecting to receive one million GBP in one year. Apple expects the spot rate of GBP to be $1.30 in a year, so it decides to avoid exchange rate risk by hedging its receivables. The spot rate of the pound is quoted at $1.32. The strike price of put and call options are $1.34 and $1.33 respectively. The premium on both options is $.02. The one-year forward rate exhibits a 3% premium. What is the best possible hedging strategy and how many U.S. dollars Apple will receive under this strategy?

6. Suppose that a call option to buy GBP for $1.32 costs $0.02 and is held until maturity. Under what circumstances will the holder of the option make a profit? Under what circumstances will the option be exercised? Can the option be exercised and the holder makes a loss?

Answer 1

Answers :

1. Amount paid in AUD at the end of the one year = 100m *1.60AUD = 160m AUD.

Here call option(right to buy) is exercised at a strike price of 1.61 which is more than spot price at the end of 1 year ,hence option not exercise at loss.

2. Option is recommend and Net amount received under is option is $ 1.3132 million.

Workings:

a) Evalution of option :(put option)

Proceed under option = 1million *$1.34 = $ 1.34 million

Option premium = $ 1.34 m*$ 0.02 = $ 0.0268 million

Net proceeds $1.34 -$0.0268 = $ 1.3132 miilion

b) Evaluation of forward contract

Assume Option strike price is same for forward

Proceeds under forward = 1m*$ 1.34 = $ 1.34million

Forward premium = 1.34m *3% = $ 0.0402 million

Net proceed under forward = $ 1.34 - $ 0.0402 = 1.2998 million

Conclusion : option is recommended

3. 1 Call option will be profitable when spot rate on maturity more than strike price and amount of premium paid cover by the profit or premium paid less than the amount of profit.

3.2 The call will be exercised when the spot rate on maturity is more than strike price

Here call option will exercise if the spot rate on maturity is higher than strike price for example if spot rate becomes $ 1.34 whch is more than strike price.

3.3. No , option is a right not an obiligation ,option should exercise at loss.