Assume the current spot rate is $1.1201/, and U.S. Dollar ($) is the home currency. A...

   

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Assume the current spot rate is $1.1201/€, and U.S. Dollar ($) is the home currency. A CALL option on Euro (€) has a strike price of $1.2040/€ and a premium of $0.00038/€. Assume a U.S. company will purchase the option for hedging a cash flow amounting to €1m Account Payable due in 6 months. The weighted average cost of capital (WACC) of the purchaser is 15% p.a. i. Determine break-even price for the option. ii. For a buyer, when the spot rate is $1.2404/€, is the option at-the-money, or in-the-money, or out-of-the- iii. Determine net profit for the option if the spot rate is $1.2770/€. iv. Assume 6 months forward rate is $1.1825/€. Is the forward market hedge or the option market hedge a better choice for the company? Show relevant calculations. better choice for the company? Show relevant calculations. [Hint: For (iv), do a similar transaction exposure calculation like we have covered during week 7. For option hedging, note that premium is given in dollar per foreign currency amount rather than as a percentage. Thus, a premium of $0.0001/¥ means, for an option amounting to ¥10,000, the premium paid is: ¥10,000 x $0.0001/¥ = $1. Similar idea is to be used in this math] Assume the current spot rate is $1.1201/€, and U.S. Dollar ($) is the home currency. A CALL option on Euro (€) has a strike price of $1.2040/€ and a premium of $0.00038/€. Assume a U.S. company will purchase the option for hedging a cash flow amounting to €1m Account Payable due in 6 months. The weighted average cost of capital (WACC) of the purchaser is 15% p.a. i. Determine break-even price for the option. ii. For a buyer, when the spot rate is $1.2404/€, is the option at-the-money, or in-the-money, or out-of-the- iii. Determine net profit for the option if the spot rate is $1.2770/€. iv. Assume 6 months forward rate is $1.1825/€. Is the forward market hedge or the option market hedge a better choice for the company? Show relevant calculations. better choice for the company? Show relevant calculations. [Hint: For (iv), do a similar transaction exposure calculation like we have covered during week 7. For option hedging, note that premium is given in dollar per foreign currency amount rather than as a percentage. Thus, a premium of $0.0001/¥ means, for an option amounting to ¥10,000, the premium paid is: ¥10,000 x $0.0001/¥ = $1. Similar idea is to be used in this math]

Answer rating: 100% (QA)

Lets break down each question and handle them one by one i Determine breakeven price for the option The breakeven price for the option is the strike price plus the option premium This gives the price ... View the full answer