Question

1.) Options Hedging: On March 15, a US firm is planning to import Indian software worth Rs. 1 million due on April 15 (one day later). Firm decides to hedge its payables position by using OTC April 15 call option on the rupee. The spot rate is US $0.0220/rupee and the April call for X= $ 0.0200 / rupee is quoted at $0.0010/rupee. On April 15, the spot rate settles at $ 0.0190 / rupee.

a.) What is the cost of the call option in dollars? Do you exercise the call or not?

b.) What is the dollar payables from options hedging?

2.) A U.S. firm can hedge its South African rand receivables against depreciation by:

a. selling rand futures                                 b. buying rand futures

c. buying rand forward                               d. none of the above

                                           

Answer 1

a) Cost of the call option in dollars = $0.0010/rupee * 1,000,000 rupee

Cost of the call option in dollars = $1,000

You do not exercise the call option because, on April 15, you can buy rupee at a lower rate ($0.0190/rupee) than the strike price ($0.0200/rupee)

b) Dollar payable = 0.0190 * 1,000,000 = $19,000

Note that you have already paid $1,000 to purchase the call option.

2. A U.S. firm can hedge its South African rand receivables against depreciation by:

a. selling rand futures

Enter into a contract today to sell rand in the future at the rate agreed today. So, even when the rand depreciates you can sell rand at the agreed upon rate.

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