Question

. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is:

Future Spot Rate	Probability
$.46	10%
$.48	35%
$.52	55%

What is the probability that the put option will be exercised (assuming Arizona purchased it)?

	a.	10%.
	b.	35%.
	c.	45%.
	d.	55%.

Answer 1

Put option of a contract is exercised whenever the future spot rate are lower than the exercise price.

In the given question the put option will be exercised in the first two scenario when future spot rates i.e. $ 0.46 and $ 0.48 are less than the exercise price which is $ 0.50

So, the probability associated with these two future spot rates are:

= 10% + 35%

= 45%

So, the correct answer is option c.

Feel free to ask in case of any query relating to this question