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Hello;please may I kindly get some help on this question. I am kind of totally lost because this is not how I go about my currency option questions so its kinda throwing me off guard.
for currency options I first of all find my number of contracts, then I find the premium amount and convert it at spot, and find the under/overhedge and convert it using forward rate, then I then use the information to find my receipt or payment. The approach of this question is not quiet clear to me.
What you have written would be the correct approach for traded options.
However, the question says that they are OTC (over the counter) options. This means that it is a specific deal with the bank to have the right to convert the exact amount at the rate agreed. So if they choose to exercise the option then they will convert the whole amount at the agreed rate – they are not restricted to contract size and there is no over or under hedge as a result.
ok, so can I kindly get the best approach to tackle OTC options? because I don’t understand how they initially started by finding the receipt using the swap arrangement when the receipt was already stated in the question?
The question asks you to compare using a swap or using options.
If they swap then they end up with $1,044M (as calculated in the previous part of the question).
If they use options instead of swapping, then they have the choice of converting the receipt of $7,500M at whatever the spot rate happens to be (which here is predicted to be 0.1315) or instead converting the $7,500M at the exercise price. Here, if the exercise price is $7.75 then they would not exercise the option and would convert at spot. If the exercise price is $7.25 then they would exercise and convert at $7.25. In both cases, of course, there would be the premium payable whether or not they exercised.
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