- This topic has 2 replies, 2 voices, and was last updated 1 year ago by anonymous570.
- June 1, 2019 at 3:19 pm #518215anonymous570
Chapter 11 Lecture had at one point during second half the following example question. I didn’t understand the solution (excercise the option if exchange rate is €/$ 0.70 and allow option to lapse if exchange rate is €/$ 0.80). I’d really appreciate if someone could explain please. My own working/reasoning is below along with the question/example. Thanks a lot :).
A French company is importing goods costing $200,000 from the US.
The current exchange rate is €/$ 0.75 and payment will have to be in 3 months.
The company buys a 3 month option for € 4,000 at an excercise price of €/$ 0.77.
What will the total cost of the import be if the exchange rate moved to:
i) €/$ 0.70
ii) €/$ 0.80
If excercised, the option leads to import cost at 200,000*0.77 = €154,000.
i) Under €/$ 0.70 exchange rate, import cost would be 200,000*0.70 = €140,000.
So, the import cost under the exchange rate is cheaper for the French company than if the option were to be excercised, making it best to simply allow the option to lapse (for a cheaper deal with the import cost).
ii) Under €/$ 0.80 exchange rate, import cost would be 200,000*0.80 = €160,000.
So, import cost under the exchange rate is actually more expensive than if the option were excercised, making it best to excercise the option.June 2, 2019 at 7:32 pm #518438Ken GarrettKeymaster
I’ve looked at this and must apologise. I got the lapse/exercise advices the wrong way round. Your reasoning is perfect.June 3, 2019 at 7:29 am #518474anonymous570
OK, thanks for letting me know 🙂
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