Question

The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.60/€. Consider a three-month American call option on €62,500 with a strike price of $1.52/€. If you pay an option premium of $2,500 to buy this call, at what exchange rate will you break-even? a $1.56/€ O b. $1.58/€ o $1.54/€ Od $1.521€ Question 15 of 25 S a ve this response

Answer 1

$2500 is paid to buy call options on Euro 62500

So, For every Euro , premium paid = $2500/62500 = $0.04

The Call option will be beneficial to the holder if the Dollar depreciates against the Euro i.e. the amount of dollar paid per Euro increases.

As the strike price = $1.52 /Euro

The Option breaks even when the Exchange rate = $1.52 /Euro + $0.04/Euro

= $1.56/Euro (1st option)

This happens becuase the Option holder can exericise the option at this exchange rate and buy Euro 62500 by paying the strike price $1.52/Euro i..e a total of 62500*1.52 = $95000 and sell the 62500 Euros so obtained in the market at an exchange rate of $1.56/Euro to get 62500*1.56 = $97500 , thereby offsetting the cost of $2500 options purchase and breaking even