2 terms might be in your exam Exercise price only for the call option Premium

2 terms might be in your exam exercise price only for

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2 terms might be in your exam - Exercise price (only for the call option) - Premium Cost of call options - Based on currency forecast o If company “A” Hedges its payables of Euro 100,000 with call option o Exercise price $1.20 and premium of $.03 o Company forecasts the spot rate at the time when payables are due $1.16 (20% probability)
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$1.22 (70% probability) $1.24 (10% probability) Use of Currency Call Options for Hedging Euro Payables (Exercise Price = $1.20, Premium = $.03) (1) Scenario (2) Spot Rate (market) When Payables Are Due (3) Premium Per Unit Paid On Call Option (4) Amount Paid Per Unit (Including Premium When Owning A Call Option) (5) Dollar Amount Paid For 100,000 Euro When Owning A Call Option 1 $1.16 $.03 $1.19 $119,000 2 1.22 .03 1.23 123,000 3 1.24 .03 1.23 123,000 Expected cost of call option Expected Cost of Call Option = $119,000* 20% + $123,000* 80% = $122,200 Hedging Techniques Expected Cost of Call Option = $122,200 Cost of Forward Contract = $120,000 Which hedging technique should be selected? Cost of call option Advantage : provides an effective hedge
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Disadvantage : premium must be paid Consideration of Alternative Call Options Several different types of call options may be available, with different
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