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 $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60,

A.	the firm will realize $1,145,000 on the sale net of the cost of hedging.

B.	the firm will realize $1,150,000 on the sale net of the cost of hedging.

C.	the firm will realize $1,140,000 on the sale net of the cost of hedging.

D.	none of the above

Answer 1

Sales amount = €1,000,000

Strike price on put option = $1.65 per euro

Put option premium = $ 0.01 per euro

On maturity exchange rate = $1.60

Put option value = Strike price - Market price

=1.65 - 1.60

= $0.05 per euro

Net profit per euro = Put option value - put option premium

=0.05- 0.01

=$0.04

On Date of receipt firm will realize €1,000,000 and get exchanged with current rate $1.60

So, proceeds from sales 1.60 * 1000000= $1,600,000

Profit on put option 0.04 * 1000000 = $40,000

So, amount received net of hedging = $1,640,000

So, Answer is D, none of above, as amount received shall be $1,640,000