Question

Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the minimum amount of total dollar received (after accounting for the option premium) if the firm use put option to hedge: exercise price = $.61, premium = $.02, spot rate = $.60, expected spot rate in 30 days = $.56, the firm’s cost of capital (for 30 days) is 1%.

Answer 1

As per the given information, we can calculate the amount of total dollars received as follows

Exercise price = $ 0.61

Premium = $ 0.02

Spot rate = $ 0.60

Expected spot rate in 30 days = $ 0.56

With the information available, we can state that if the firm purchases the put option, then it can exercise the put option, if the excercise price is higher than the expected spot price in 30 days

As the Excercise price is $ 0.61 and expected spot rate is $ 0.56, so the company will benefit by excercising the put option.

So, the total dollar received (after accounting for the option premium) is

= ( Exercise price - option premium) * amount to be received

= ( 0.61 - 0.02) * 1,000,000

= 0.59 * 1,000,000

= $ 590,000

Therefore the amount of total dollars received by exercising the put option is $ 590,000

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