Question

A U.S. company wants to use a currency put option to hedge 10 million Danish Krone (DKR) in accounts receivable due in six months. The premium of the currency put option with a strike price of $0.1333 per DKR is $0.01. The spot rate at the expiration is DKR7.20 per USD. The cost of capital for the company is 10%.

What would be the net amount USDs received by the company in exchange for the DKR 10 million if the time value of the option premium is incorporated?

a. $1,333,333

b. 1,228,333

c. 1,388,888

d. 1,283,889

e. None of the above

Answer 1

Strike Price = 1DKR= 0.1333$

Time = 6 months

Premium = 1DKR= 0.01$

Spot Price = 1$= 7.20DKR

1DKR= 1/7.20$

1DKR= 0.1388$

Since, the strike price of the option is less than the spot price at the end of 6 months. Therefore, the company will not excercise put option and sell the DKRs at the spot price. The net amount in USDs received by the company in exchange for the DKR 10 million when the time value of the option premium is incorporated will be-

1DKR= 0.1388$

10millionDKR = 13,88,888$

Less-Option Premium=(10million*0.01$)   -1,00,000$

Less- Cost of Capital on option premium (100000*10%*6/12)   - 5,000$

Net amount received by US Co= 12,83,889$

Option(d) is the correct answer.