Question

Please show the steps on how to solve this problem

A U.S. corporation has purchased currency put options to hedge a 100.000 Canadian dollar (CS) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally? a $75,000. Ob $85.000 oc $74.000 od $84.000.

Answer 1

The corporation is hedging a C$ receivable. That is, the corporation seeks to hedge the amount of $ it will receive when it converts C$100,000 into $.

It purchases put options on the C$ with strike price of $0.75/C$.

If the spot rate at time of maturity is less than the strike price, it will exercise the options as it can receive a higher amount of $ by exercising the call option than selling the C$ in the spot market.

If the spot rate at time of maturity is more than the strike price, it will not exercise the options as it can receive a higher amount of $ by selling the C$ in the spot market than exercising the call option.

The spot rate at time of maturity is more than the strike price. Hence, it will not exercise the options, and the options will expire worthless. The premium paid to buy the put options is lost.

net amount received = (spot rate at time of maturity - premium paid) * amount of C$ sold

net amount received = ($0.85 - $0.01) * 100,000

net amount received = $84,000

The answer is (d)