Question

A firm wants to use a CALL option to hedge CAD 10 million in payables to Canadian firms. The premium is $.02. The exercise price is $1.10 per CAD. At the expiration date, the spot rate is $1.25. What is the total amount of dollars your company has to pay(after accounting for the premium paid)?

Answer 1

Solution:

A Call option will be exercised only if, the expiration date spot rate is greater than the exercise price of the Call option.

As per the information given in the question we have

Exercise price of Call option = $ 1.10 per CAD

Expiration date spot rate a Call option = $ 1.25 CAD

Since the expiration date spot rate is greater than the exercise price of the Call option, the Call option will be exercised.

As per the information given in the question we have

CAD in Payables = 10 million

Premium paid per Call option contract = $ 0.02

Thus the total amount of dollars payable = CAD Payables * ( Exercise Price – Premium paid )

= CAD 10 Million * ( $ 1.10 - $ 0.02 )

= CAD 10 Million * $ 1.08

= $ 10.8 Million

Thus the total amount of dollars payable (after accounting for the premium paid) = $ 10.8 Million.