Question

LKL Corporation will need 217,000 Canadian dollars (C$) in 90 days to cover a payable position. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. LKL plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $0.76, what is the net amount paid, assuming LKL wishes to minimize its cost?

Answer 1

LKL Corporation will need 217,000 CAD in 90 days to cover a payable position.

It need 217,000 CAD in 90 days

So Buying a 90-day call option with an exercise price of $0.75 with premium .01$ is the best option to risk aversion

Total premium paid will be $ 2170 (CAD 217,000 * $0.01).

After 90 days, exercise price of the call option is $0.75 whereas the spot rate in 90 days is $0.76

So call will be exercised

Net Amount paid = Cash outflow for exercising option + Premium paid to buy call option

= (CAD 217,000 *$0.75) + $ 2170

= 162750 $+ 2170$

  Net Amount paid    = 164,920 $