Question

Verizon buys a 1.3 $/pounds strike put to hedge a 100,000 pounds AR due in 1 month and sells 200,000 pounds in a 1.3 $/pounds strike call to offset the cost of the put. Suppose the exchange rate turns out to be 1.2 $/pounds at the expiration. What is the dollar value of the AR hedged with the options strategy. Write all calculation required

Answer 1

The dollar value of the AR hedged can be arrived with the use of following formula:

Dollar Value of AR Hedged = Value of the AR + Value of the Put - Value of the Call

Using the values provided in the question in the above formula, we get,

Value of the AR = 100,000 Pounds*1.2$/pounds = $120,000

Value of Put = 100,000 Pounds*(1.3 - 1.2) = $10,000

Value of Call = 0 (Verizon will let the call expire as the exchange rate has declined)

Now, we can arrive at the value of AR hedged as follows:

Value of AR Hedged = 120,000 + 10,000 - 0 = $130,000