Question

A firm wants to use a PUT option to hedge NZD 10 million in receivables from New Zealand firms. The premium is $.02. The exercise price is $.50. At the expiration date, the spot rate is $.40. What is the total amount of dollars received (after accounting for the premium paid)?

Answer 1

Solution:

A Put option will be exercised only if, the expiration date spot rate is lesser than the exercise price of the put option.

As per the information given in the question we have

Exercise price of Put option = $ 0.50

Expiration date spot rate a put option = $ 0.40

Since the Exercise price of Put option is greater than its Expiration date spot rate the put option will be exercised.

As per the information given in the question we have

NZD in receivables = 10 million

Premium paid per Put option contract = $ 0.02

Thus the total amount of dollars received = NZD Receivables * ( Exercise Price – Premium paid )

= NZD 10 Million * ( $ 0.50 - $ 0.02 )

= NZD 10 Million * $ 0.48

= $ 4.8 Million

Thus the total amount of dollars received (after accounting for the premium paid) = $ 4.8 Million.