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Sir, i have query regarding the currency option.
For the currency option exercise price at $1.38 should we not exercise it?
Because if we assumed the spot rate in 4 months time is $1.3623 which is lower than the exercise price then we should not exercise it
We should convert all the amount receipt of $20m at $1.3623 minus the premium
But why examiner answer exercise the 1.38 option?
But you can’t assume that the spot rate will be 1.3623 in 4 months time. The questions mentions considerable uncertainty.
If it did turn out to be 1.3623 then certainly we would not exercise the 1.38 option. But since we are uncertain, the receipt calculated assuming the option is exercised is the worst that can happen – the actual receipt might end up being higher but cannot be lower.
But if in real exam if i wrote i assumed the spot rate is 1.3624 in 4 months time and do calculation for not exercise the 1.38 option is it incorrect and examiner will not give me marks?
You will still get the marks provided that you state your assumption and that you have shown enough to prove that you know how options work (i.e. that they limit the worst outcome).
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