FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $.71, what is the net amount paid, assuming FAB wishes to minimize its cost?

Question

Quizplus · Accepted Answer

FAB Corporation will exercise the call option since the spot rate ($.71) is below the exercise price ($.75). The cost will be 200,000 C$ * $.75 = $150,000. Adding the premium cost of 200,000 C$ * $.01 = $2,000, the total cost is $152,000. However, since the spot rate is lower than the exercise price, FAB would not exercise the option and instead buy at the spot rate, costing 200,000 C$ * $.71 = $142,000. Adding the premium of $2,000, the net amount paid is $144,000.

FAB Corporation Will Need 200,000 Canadian Dollars (C$) in 90