PSG Inc., a U.K. manufacturer, is expecting an inflow of 18.3 million US-$ within the next four months. Today’s spot exchange rate is 0.7407 British pounds (£) per US-$. PSG decides to hedge using options. The £ interest rate is 1.79%. PSG contacts Citicorp which offers the following options on the US-$:

- American call option on the US-$ with T=3 months, K=0.74 £/$, and price C=0.025 £/$

- American put option on the US-$ with T=3 months, K=0.74 £/$, and price P=0.012 £/$

- American call option on the US-$ with T=6 months, K=0.74 £/$, and price C=0.029 £/$

- American put option on the US-$ with T=6 months, K=0.74 £/$, and price P=0.015 £/$

Answer the following questions, assuming that these options have no resale value, and ignoring transactions costs.

a) Which option should PSG choose?

b) Suppose that 5.5 months later PSG receives the 18.3 million US-$ payment. At that time (t=5.5 months) the spot exchange rate is 0.68 £/$. What should PSG do? How many £ per US-$ will they receive net of the expense for the purchase of the option?

c) Now, suppose that 5.5 months later (i.e., at the time when PSG will receive 18.3 million US-$) the spot exchange rate is 0.78 £/$. What should PSG do? How many £ per US-$ will they receive net of the expense for the purchase of the option?

Answer rating: 100% (QA)

a Since PSG has Receivables that will be received at any time in next four months it should chose op... View the full answer