Question

# On December 1, 2018, Keenan Company, a U.S. firm, sold merchandise to Velez Company of Canada...

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.

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 .

= \$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 .

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