FAB Corporation will need 200,000 Canadian dollars (C$)in 90 days to cover a payable position.Currently,a 90-day call option with an exercise price of $.75 and a premium of $.01 is available.Also,a 90-day put option with an exercise price of $.73 and a premium of $.01 is available.FAB plans to purchase options to hedge its payable position.Assuming that the spot rate in 90 days is $.71,what is the net amount paid,assuming FAB wishes to minimize its cost

Question

Quizplus · Accepted Answer

To minimize the cost, FAB should purchase put options with an exercise price of $.73. If the spot rate in 90 days is $.71, FAB can exercise the put option and sell C$200,000 for $0.73 each, receiving $146,000. Subtracting the premium of $0.01 per option, the net amount paid is $0.72 per CAD, which comes to a total cost of $144,000. Compared to the call option, purchasing put options is a more cost-effective strategy for FAB in this case. Therefore, the net amount paid is $140,000 (200,000 x 0.72).

FAB Corporation Will Need 200,000 Canadian Dollars (C$)in 90 Days