Question

An importer of Swiss watches has an account payable of CHF750,000 due in 90 days. The following data is available:

Rates and prices in US-cents/CHF.

Spot rate: 71.42 cents/CHF

90-day forward rate: 71.14 cents/CHF

US –dollar 90-day interest rate: 3.75% per year

Swiss franc 90-day interest rate: 5.33% per year.

Option Data in cents/CHF

_______________________________

Strike Call Put

70 2.55 1.42

72 1.55 2.40

_______________________________

a) Assess the USD cost to the importer in 90 days if it uses a call option to hedge its

CHF750,000 account payable. Use the call with a strike price of 72 cents/CHF.

b) What will be the cost of the payable in 90 days if a forward contract is used?

c) By how much must the CHF weaken relative to the USD, from 71.42 cents/CHF before the

call option provides a lower cost than the forward hedge?

Answer 1

a)the premium to be paid at strike price of 72 for a call option is 1.55 cents/CHF. This is to be paid immediately at spot rate i.e. 10417 contracts*1.55/100*71.42= 11,531dollars. As the future spot 71.15 is less than strike price, this call option will not be exercised. So the cost =( 750000*71.15/100)+11531= 545,156 dollar.

b)cost= 71.14*750000/100= 533,550 dollar

c) call option provides higher cost. Forward contract is better. Call option must have a strike price of less than 71.15 in order to exercise. Options would provide a lower cost at 70 strike price.