Lakewood Products, Inc. just bought €2,650,000 in products from a French supplier with payment due in 30 days. The spot exchange rate today is $1.2300/€ and the 30-day forward rate is $1.2310/€. Lakewood is afraid that the dollar will depreciate significantly more than the amount implied in the forward rate, but some of its economics staff are predicting that the dollar will strengthen. The Lakewood CFO thinks that this may be a good time to consider OTC currency options. Both puts and calls on euros are available for 30 days at a strike price of $1.2310/€ and a 0.25 percent premium. If the U.S. 30-day interest rate is 0.45 percent per month (5.4 percent per annum), what is the breakeven future spot rate at which the OTC option costs the same as remaining unhedged?

Question

Quizplus · Accepted Answer

The breakeven future spot rate for the OTC option, considering the premium, is calculated by adding the premium cost to the strike price. The premium is 0.25% of the strike price of $1.2310/€, which equals $0.0030775 (0.0025 * 1.2310). Adding this premium to the strike price gives $1.2340775/€, which rounds to $1.2341/€, matching closest to option A, $1.234089/€. This calculation assumes the cost of the option premium is the only additional cost to consider for the breakeven point.