A Japanese exporter has a €1,000,000 receivable due in one year.Estimate the cost today of an options strategy that will eliminate exchange rate risk. $\begin{array}{llll}
\text { Listed Options }\
&\text { Strike } & \text { Puts } &\text { Calls } \
\text { Euro€62,500 } & \$ 1.25=€ 1.0 C & \$ 0.0075 \text { per } € & \$ 0.01^{ per€ } \
\text { Yen?12,500,000 } & \$ 1.00=¥ 10 C & \$ 0.0075 \text { per } ¥ 100 & 0.010^{ per ¥10 }
\end{array}$
A)$20,000
B)$5,000
C)$12,500
D)none of the options

Question

A Japanese exporter has a €1,000,000 receivable due in one year.Estimate the cost today of an options strategy that will eliminate exchange rate risk. $\begin{array}{llll}
\text { Listed Options }\
&\text { Strike } & \text { Puts }  &\text { Calls }  \
\text { Euro€62,500 } & \$ 1.25=€ 1.0 C & \$ 0.0075 \text { per } € & \$ 0.01^{ per€ } \
\text { Yen?12,500,000 } & \$ 1.00=¥ 10 C & \$ 0.0075 \text { per } ¥ 100 & 0.010^{ per ¥10 }
\end{array}$
A)$20,000
B)$5,000
C)$12,500
D)none of the options

Quizplus · Accepted Answer

To eliminate exchange rate risk, the Japanese exporter can use a currency options strategy known as a covered call. This involves selling call options on the currency they will receive (in this case, euros) while holding an equal amount of the underlying currency (euros) to deliver to the option holder if the option is exercised.

In this case, the exporter would sell 16 euro calls with a strike price of €62,500, using the premium they receive to buy 160 yen puts with a strike price of ¥12,500,000. This strategy would fully hedge their euro receivable while allowing them to benefit from any appreciation in the yen.

The cost of this strategy is the difference between the premium received for selling the euro calls and the premium paid for buying the yen puts.

Premium received for selling 16 euro calls:

$0.01 x €62,500 x 16 = $10,000

Premium paid for buying 160 yen puts:

$0.0075 x ¥10 x 12,500,000/100 x 160 = $30,000

Cost of options strategy:

$30,000 - $10,000 = $20,000

Therefore, the best choice is A) $20,000.

A Japanese Exporter Has a €1,000,000 Receivable Due in One