Question

The premium on a June 17 British pound call option with a strike price of $1.2560 when the spot rate is $1.2620 is quoted as $0.02. The time value of this option is.

The premium on a June 17 British pound call option with a strike price of $1.2750 when the spot rate is $1.2620 is quoted as $0.025. The intrinsic value of this option is.

Your firm has an accounts receivable worth C$200,000 due in six months. The firm buys 2 June 16 Canadian dollar put options with a strike price of $0.9750 at a premium of $0.0075 to hedge against the exchange risk. If the spot rate in June settles above the strike and current interest rate dollar 2%, the outcome of the hedge will be exactly $193,483. Yes or no? explain>

Manual work, not excel

Answer 1

• Calculation of Time Value of money

Premium $0.02

Strike Price $1.2560

Spot rate $1.2620

Intrinsic value =Strike price – spot price

                             1.2560-1.2620= -0.006

Time value of option = Premium – intrinsic value

                                            0.02-(0.006)

Time value of option =$0.026

• Calculation of intrinsic value

Premium $0.025

Strike Price $1.2750

Spot rate $ 1.2620

Intrinsic value= Strike price – spot price

                              1.2750-1.2620

Intrinsic value = $ 0.013

• Hedging

Yes, outcome of hedging will be $193483

Explanation

Our firm has C$ 200000 receivable after six month .So to hedge itself firm buy put option with strike price of $0.9750 at premium of $0.0075

Premium $0.0075*200000= $1500

$ interest rate=2%

Opportunity cost = 1500*1.01=1515

If option exercises = 200000*0.9750=195000

Outcome= 195000-1515=$193485

However if the spot price after six month rises above strike price the option should not be exercise.