Question

Apex Corporation of Canada must pay its Japanese supplier Yen 125 million in three months. Apex's CFO is considering to hedge this transactional risk by purchasing options on Yen, at a strike price of $0.008/Yen. The option premium is 0.015 cents ($0.00015) per yen for calls and 0.008 cents ($0.00008) per yen for puts. The current spot rate is $0.007823/Yen. Apex's treasurer believes that the most likely value for yen in 90 days is $0.0079, but the yen could go as high as $0.0084 or as low as $0.0075. Your task is to determine whether to buy calls or puts and answer the following questions:

a. If the Yen settles for its most likely value in three months, what should Apex do and what are the gains/losses from its options contract? (1 point)

b. What will be the total expenditure for Apex if the yen increases to its high? (1 point)

Show Work

Answer 1

a). Since Apex has to pay Yen 125 million (Accounts payable A/P), it needs to buy call options (since it will need to buy Yen in order to pay the supplier).

Option premium cost = A/P amount*premium per Yen = 125,000,000*0.00015 = $18,750

If, after three months, Yen is at the most likely value of $0.0079 then the call option will not be exercised (since it is less than strike value). So, Dollar cost of converting to Yen will be 125,000,000*0.0079 = $987,500.

Total cost = 987,500 + 18,750 = $1,006,250

Net loss from using the options contract is 18,750 (cost of option premium).

b). If Yen increases to $0.0084 then exercising the option at the strike price of $0.008 will cost less so dollar cost wll be

125,000,000*0.008 = $1,000,000

Total expenditure = 1,000,000 + 18,750 = $1,018,750