Assume that Smith Corp. will need to purchase 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium.
A) $360,000
B) $338,000
C) $332,000
D) $336,000
E) $344,000

Question

​Assume that Smith Corp. will need to purchase 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium.
A) ​$360,000
B) ​$338,000
C) ​$332,000
D) ​$336,000
E) ​$344,000

Quizplus · Accepted Answer

Smith Corp. will buy the call option to hedge against the pound appreciating. The total cost will be the exercise price ($1.68) plus the premium ($0.04) per pound. Therefore, the total cost is 200,000 pounds * ($1.68 + $0.04) = $344,000.

​Assume That Smith Corp

Assume That Smith Corp