A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year the U.S. firm gets paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60,

Question

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To hedge the sale, the U.S. firm has bought put options on euro with a strike price of $1.65 and an option premium of $0.01 per euro.

At maturity, if the exchange rate is $1.60, the put option will be exercised and the U.S. firm can sell euros at the higher strike price of $1.65.

The net amount received by the U.S. firm will be the sale price of €1,000,000 converted to U.S. dollars at the exchange rate of $1.60, minus the cost of the option premium and the difference between the spot exchange rate and the strike price.

So, the net amount received will be:

€1,000,000 * $1.60/EUR - €1,000,000 * $1.65/EUR + option premium = $1,140,000 - $10,000 + $10,000 = $1,140,000

Therefore, the firm will realize $1,140,000 on the sale net of the cost of hedging.

A US Firm Has Sold an Italian Firm €1,000,000 Worth of of Product