Question

You are UK company, 400,000 US$ payable to US in one year. Answer in terms of BP (British Pound).

Round at four decimal places Examples: 1.23487 ---> 1.2349; 1.23533 --> 1.2353

Information for Forward Contract:

Forward exchange rate (one yr): 0.7124 BP/$

Information for Money Market Instruments (MMI):

Current exchange rate: 0.7173 BP/$

Investment return at JP Morgan (in US): 5% annual

Interest rate of borrowing from HSBC (UK): 4% annual

Information you need for Currency Options Contract:

Exercise options premium at 0.09 BP/$

Interest rate of borrowing from HSBC (UK): 3% annual

Allowed to exercise options at 0.7215 BP/$  

Let's assume you signed the COC contract in this scenario. If the actual exchange rate at the time of payment is .7320 BP/$, should you exercise the option?  

Group of answer choices

No

Yes

Answer 1

Answer is YES

Exercise Option premium at 0.09BP/$

Interest rate of borrowing from HSBC(UK): 3% annual

Allowed to exercise option at 0.7215 BP/$

Actual exchange rate at the time of payment is 0.7230 BP/$

Total Outflow when Exercise :

Amount of payable at exercise price 288,600 BP ($40,000*0.7215 BP)

Total Outflow when Not Exercise 292,800 BP ($40,000*0.7320 BP)

Exercise option premium at 0.09 BP/S Interest rate of borrowing from HSBC (UK): 3% annual Allowed to exercise option at 0.7215 BP/S Actual exchange rate at the time of payment is 0.7230 BP/$ Total outflow when exercise Amount to payable at exercise price 288600 BP ($ 4,00,000 X 0.7215 BP) Total outflow when not exercise 292800 BP ($ 4,00,000 X 0.7320 BP) Since outflow is lower when exercise the contract, it is recomonded to excercise the contract.