The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00.Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00.If you pay an option premium of $5,000 to buy this call,at what exchange rate will you break-even?
A)$1.58 = €1.00
B)$1.62 = €1.00
C)$1.50 = €1.00
D)$1.68 = €1.00

Question

Quizplus · Accepted Answer

To break-even on the call option, you need the spot exchange rate to exceed the breakeven exchange rate.

Breakeven exchange rate = strike price + option premium / forward rate
Breakeven exchange rate = ($1.50 + $5,000/€62,500) / $1.60/€1.00
Breakeven exchange rate = €0.024 / €1.00 = €1.024

To convert this to dollars per euro, we take the reciprocal: 1/1.024 = $0.977.

Therefore, the breakeven spot exchange rate is $0.977/€1.00. If we invert this rate, we get €1.024/$1.00, which is equivalent to $1.58/€1.00. Therefore, we need the spot exchange rate to be above $1.58/€1.00 to profit from the call option.

The Current Spot Exchange Rate Is $1