Question

A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year the U.S. firm gets paid to hedge, the U.S. firm bought put options on the euro with a strike price of $1.45 per euro They paid an option premium $0.02 per euro. If at maturity, the exchange rate is $1.40, a. the firm will realize $1,430,000 on the sale net of the cost of hedging. b. none of the other answers c. the firm will realize $1,450,000 on the sale net of the cost of hedging. d. the firm will realize $1,400,000 on the sale net of the cost of hedging

Answer 1

ans: a)  the firm will realize $1,430,000 on the sale net of the cost of hedging.

Since the Firm bought a put option at strike price of $1.45/ euro, the US exporter Firm will gain if the spot rate falls below the strike price on maturity. Hence, gain at maturity as per question= payoff- premium paid

   = ((1.45-1.40)*1,000,000) - (0.02*1,000,000)

  = $ 30,000

Also, at maturity the Firm will also receive the sales receivable at the prevailing exchange rate, i.e, $1.40/euro

Received= 1.40* 1,000,000= $ 14,00,000

Thus, total realization of the Firm = 14,00,000+ 30,000= $ 14,30,000

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