You are a U.S. importer and just placed an order of antiques worth £100,000 from a U.K supplier.  You owe £100,000 to the U.K seller in one year.  You are concerned about the dollar cost of this purchase in one year and decide to hedge your exchange rate risk using options.

The current spot exchange rate is $1.45/£, and the forward exchange rate is $1.40/£. The U.S. interest rate is 2.00%, and the U.K. interest rate is 4.00%. A call option with a strike price of $1.40/£ is available with a premium of $0.10/£. A put option with a strike price of $1.40/£ is available with a premium of $0.08/£.  

What will be your total dollar cost of this purchase in one year with options hedge if the spot rate in one year turns out to be $1.30/£? Consider whether you will exercise your options if the future spot rate tuns out to be $1.30/£. Enter the numeric portion of your answer.

Answer rating: 100% (QA)

SOLUTION To hedge the exchange rate risk we can use a combination of a forward contract and options ... View the full answer