Question

2) GED Corporation, located in the United States, has an accounts payable obligation of ¥800 million payable in one year to a bank in Tokyo. The current spot rate is ¥115/$1.00 and the one year forward rate is ¥110/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0080 per yen for a premium of 0.010 cent per yen. The maximum future dollar cost of meeting this obligation using the call option is A) 6400000 B) 6484800 c) 6880734 d) 6545400

Answer 1

using a currency option

Company needs to buy call option

The call option premium : YEN 800 MILLION = 0.010 CENT PER YEN

So for YEN 800 MILLION x (0.010/100) $ = $ 0.08 MILLION

At 6% rate of interest, the total cost = 0.08 (1+0.06) =$ 0.0848 million

Now if YEN appreciates, there is no problem but YEN depreciates then, company will exercise the option & will buy YEN 800 million for $ 0.0080 PER YEN

In any case total DOLLAR payable is

IN DOLLAR TERMS = YEN 800 MILLION X 0.0080 = 6.4 MILLION + 0.0848 MILLION = 6.4848 million

So answer : 6484800

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