Clicker question put option hedge if maria buys the

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Clicker Question:Put Option HedgeIf Maria buys the put option, the amount she will have in 3 months depends on the future spot rate.Remember, the exercise price is X=$1.75/£.Suppose the spot rate in June is S3= $1.80/£. What should Maria do?a.Exercise the option.b.Don’t exercise the option. Instead, sell pounds in the spot market.
Suppose the spot rate in June is S3= $1.70/£. What should Maria do?
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Put Option HedgeThe worst case scenario when you hedge with an option is that you have to exercise it.For example, if the spot rate in 3 months turns out to be $1.50/£, you’d rather exercise the put option and sell pounds at X=$1.75/£.If you exercise the put (at X=$1.75/£), you’ll receive (minus the future value cost of the option):= (£ receivable ∙ X$/£) – FV cost of put option= (£1,000,000×$1.75/£) – ($26,460×1.03)= $1,750,000 – $27,254 = $1,722,7467-25Carry the cost forward at the WACCThis is the minimum you’ll receive (in $). Worst case is that you exercise the put!
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Note: Even when you don’t exercise the put, you must subtract the FV cost of the option.
Graph of Alternatives7-27$1,772,605$1,754,000Depends on future spot rateMinimum $1,722,746, Max = unlimited
Strategy Choice and OutcomeTrident, like all firms, must decide on a strategy to undertake before the exchange rate changes, but how will Maria choose among the strategies?
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Strategy Choice and Outcome
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Strategy Choice and OutcomeHedging StrategyOutcome/PayoutRemain uncoveredUnknownForward Contract hedge @ $1.754/£$1,754,000Money market hedge @ 12% p.a.$1,772,605Put option hedge @ strike $1.75/£:Minimum if exercised$1,722,746Maximum if not exercisedUnlimited7-30
What Maria Could SeeMinimum acceptable margin ($1.70/£)7-30B
What to do?What would you do?What happened to the $/£ exchange rate afterwards?7-30C
What Maria Couldn’t SeeMinimum acceptable margin ($1.70/£)3 months later: $1.4905/£7-30D
What Happened?7-30EExchange RateS3= $1.4905/£Money Market
Managing an Account Payable7-30F

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