On December 1, 2011, Keenan Company, a U.S. firm, sold merchandise to Velez Company of Canada for 150,000 Canadian dollars (CAD). Collection of the receivable is due on February 1, 2012. Keenan purchased a foreign currency put option with a strike price of $.97 (U.S.) on December 1, 2011. This foreign currency option is designated as a cash flow hedge. Relevant exchange rates follow:

Compute the fair value of the foreign currency option at February 1, 2012.

Question

On December 1, 2011, Keenan Company, a U.S. firm, sold merchandise to Velez Company of Canada for 150,000 Canadian dollars (CAD) . Collection of the receivable is due on February 1, 2012. Keenan purchased a foreign currency put option with a strike price of $.97 (U.S.) on December 1, 2011. This foreign currency option is designated as a cash flow hedge. Relevant exchange rates follow:

Compute the fair value of the foreign currency option at February 1, 2012.

Quizplus · Accepted Answer

To compute the fair value of the foreign currency option at February 1, 2012, we need to compare the spot rate on that date with the option's strike price. From the table provided, we can see that the spot rate is $.99 (U.S.) per CAD on February 1, 2012, which is higher than the strike price of $.97 (U.S.). Therefore, the option would not be exercised and would expire worthless. The fair value of the option on February 1, 2012 would be zero, so the answer is B ($4,500).