The dollar to the euro is quoted at $1.1240/€ today. Call options on the euro with an exercise price of $1.1220/€ and expiration in three months are selling for $0.0320/€. Each option contract is for €62,500. You start with $120,000.
1.) If you buy the euro calls, how much premium do you pay per contract?
2.) How many call contracts can you buy?
3.) If in three months the exchange rate is $1.1280/€: would you exercise? what would be the total payoffs? and what would be the total profits/losses?
amount avaialble = $120000
spot rate = $1.1240/euro
amount in euro = $120000/$1.1220 = 106951.87 euro
each contract is of 62500 euros,
no of call contracts that can be bought = 106951.87/ 62500 = 1.71
answer 2 : so we can buy only 1 call contract.
answer 1 : premium to be paid = 62500 euro x 0.0320 = $2000
answer 3 : As the exchage rate is higher than exercise price after 3 months, we should exercise call
total pay off = (1.1280 - 1.1220) x 62500 = $375
total loss = $2000 - $375 = $1625 ( as premium paid is higher than the payoff, there is a loss)
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