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Problem 1 (Hedging) A US exporter expects to receive £1 million in 2 months for her exports...

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Finance

Problem 1 (Hedging)

A US exporter expects to receive £1 million in 2 monthsfor her exports to the UK. The current exchange rate is US$2.30/£.She is worried that the pound might depreciate over the next 2months and wants protection against its decline but she also wantto benefit from a possible rise in £ over the next 2 months. Putoptions and call options on the £, with 2-month maturity areavailable.

  1. What should she do?

  2. Suppose the 2-month put options exercisable at US$2.50/£are trading at US$0.01. What would be her cash revenue, given youranswer in part a), if at the 2 month end the spot exchange rateturns out to be

    1. US$2.00/£

    2. US$3.00/£

  3. What would be her minimum cash revenue, no matter whatthe spot rate at the end of 2 months turn out to be?

  4. What would be the upfront cost (fee) for undertaking theappropriate options contract?

  5. What would she do if the expected £1 million at the2-month end are not received and what would be her loss if thathappens?

Answer & Explanation Solved by verified expert
3.6 Ratings (387 Votes)
Options are a type of derivative which gives the buyer of optiona right and not an obligation to buy or sell the underlying at anagreed price on or before the due date Call Option gives the buyera right to buy and a Put Option gives the buyer a right tosellIn the given question the US exporter will receive 1million in 2 months She wants to protect against the depreciationof Pound but also wants to benefit from a possible rise in PoundCall Option and Put Option on Pound are available for 2 monthsmaturity1 She    See Answer
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