Question

Spears Co. will receive SF2,000,000 in 30 days. Use the following information to determine the total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option: Exercise price = $.61 Premium = $.02 Spot rate = $.60 Expected spot rate in 30 days = $.56 30-day forward rate = $.62

Answer 1

Here the company has SF 20 lacs receivable in 30 days. Hence it is afraid of SF declining against the dollar. So the company can use an option to hedge the transaction exposure. Here the company has purchased a put option for hedging against the transaction. The following informations are given :-

Spot rate = 0.6

Premium = 0.02

Expected spot rate after 30 days = 0.56

30 day forward rate = 0.62

Excise price = 0.61

Here the company has an option to sell at 0.61. at an expected spot rate of 0.56 the company will exercise the put option since it is lower than the excise price.

So amount receivable on exercise of put option = SF 20,00,000*0.61 = $12,20,000

Premium expense for having the put option  = SF 20,00,000*$0.02  = $40,000

Net proceeds from the put option hedge = $12,20,000-$40,000 = $11,80,000