Question

You plan to visit Geneva, Switzerland in three months to attend an international business conference. You expect to incur the total cost of SF 10,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is $0.60/SF and the three-month forward rate is $0.63/SF. You can buy the three-month call option on SF with the exercise rate of $0.64/SF for the premium of $0.05 per SF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per annum in the United States and 4 percent per annum in Switzerland. Please show work.

(a) Calculate your expected dollar cost of buying SF10,000 (after including option premium) if you choose to hedge via call option on SF.

Answer 1

Answer a -

Premium = 0.05 (10000) = $500

Finding the value of $500 in 3 months = 500(1.015)= 507.5

The future expected spot rate is $0.63/sf, because this is less than excercise price, I will not excercise options. Instead I will expect to buy swiss franc at $0.63/sf. Since i will purchase sf 10000.

I will spend (0.63* 10000) = $6300. Therefore , the total future costs of buying sf10000 ,

$6300+$507.5 =6807.5

I have explained well, if you find any doubt, ask me in comment, Thank you