On December 1, 2001 Pimlico made sales to a customer in India and recorded Accounts Receivable of 10,000,000 rupees. The customer has until March 1, 2002 to pay. On December 1, 2001, Pimlico paid $500 for a put option to sell rupees at a strike price of $2.30 per 100 rupees on March 1, 2002, which was the spot rate on December 1, 2001. On December 31, 2001, the spot rate was $2.80 per 100 rupees and the option premium was $0.004 per 100 rupees. What is the fair value of the option on December 31, 2001?
A) $0
B) $500
C) $400
D) $10,000

Question

Quizplus · Accepted Answer

To calculate the fair value of the put option on December 31, 2001, we need to compare the strike price with the spot rate on that day. If the spot rate is lower than the strike price, the option will be in the money and have value. If the spot rate is higher than the strike price, the option will be out of the money and have no value.

On December 31, 2001, the spot rate was $2.80 per 100 rupees, which is higher than the strike price of $2.30 per 100 rupees. Therefore, the option was out of the money and had no intrinsic value. However, it still had time value, which is reflected in the option premium.

The option premium was $0.004 per 100 rupees, which means it cost $40 to buy one contract of 10,000,000 rupees. Since Pimlico bought one contract for $500, they paid a premium of $500/$40 = 12.5 contracts.

To calculate the fair value of the option, we need to subtract the time value of the option (option premium) from the total cost of the option (option premium + option price). The option price was $500, and the time value was $0.004 per 100 rupees or $40 per contract. Therefore, the time value of 12.5 contracts was $500 - $40*12.5 = $0, which means the fair value of the option was zero.

Therefore, the best choice is C (option had no fair value on December 31, 2001).

On December 1, 2001 Pimlico Made Sales to a Customer