Question

On December 1, 2018, 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, 2019. Keenan purchased a foreign currency put option with a strike price of $.97 (U.S.) on December 1, 2018. This foreign currency option is designated as a cash flow hedge. Relevant exchange rates follow:

Date	Spot Rate		Option Premium
December 1, 2018	$	0.97	$	0.05
December 31, 2018	$	0.95	$	0.04
February 1, 2019	$	0.94	$	0.03 Compute the fair value of the foreign currency option at February 1, 2019.                             27)             A) $7,500. B) $6,000.       C) $3,000.                 D) $1,500.            E) $4,500. Compute the U.S. dollars received on February 1, 2019.                                                         28)             A) $141,000 B) $142,500. C) $136,500. D) $138,000. E) $145,500.

Answer 1

Solution :-

Compute the fair value of the foreign currency option at February 1, 2019 :-

Here we need to find out the fair value of the foreign currency option at  February 1, 2019 .

Fair value of the foreign currency = 150,000 Canadian dollars * Option Premium

= 150,000 * 0.03

= $4,500

Fair value of the foreign currency = $4,500

So, option ( E) is correct .

Compute the U.S. dollars received on February 1, 2019 :-

Here we need to find out the Received amount at February 1,2019 .

Received amount at February 1,2019 = [ 150,000 Canadian dollars * 0.97 ] / Canadian dollars

= $145,500

Received amount at February 1,2019 = $145,500

So, the Option ( E ) is correct .

Note :-

In second question we considered $0.97 because the spot rate at February is less than the Strike Price . That's why we considered $0.97 .