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Hello!
Regarding the computation of currency options approach, is my method correct despite slightly different answers as opposed to examiner’s. Please tell me where I could be going wrong.
I have solved using your approach.
1) no of contracts = 98
2) premium payable = 98 contracts * CHF125,000 * $0.0086 = $105,350
3) determine the WORST OUTCOME = 98 contracts * CHF125,000 = CHF12,250,000
CHF 12,250,000* 1.0292 (the use of spot rate to convert it into home currency) = $12,607,700
4) under/over hedged item
=> From here, I’m getting stuck. Kindly please help me from here.Thank you.
Using 98 contracts is hedging slightly less than the exact amount (because that would need 98.4 contracts), and so it is sensible to hedge the ‘missing’ amount using forward rates.
No. of contracts = CHF12,300,000/125,000 = 98·4, say 98, hedging CHF12,250,000
Remainder to be hedged on the forward market is CHF12,300,000 – CHF12,250,000 = CHF 50,000 Receipt = CHF50,000 x 1·0358= $51,790
However it is only ever a very minor point in the exam (here is was worth 1 mark, but you would have got half a mark just my stating the possibility even if you had done no calculations 🙂 )
Don’t we multiply/divide the exercise price somewhere in the solution?
This is because I had followed your steps in solving CMC Revision lecture.
I had come to understand to take the difference of:
WORST OUTCOME amount multiplied or divide the exercise price
(-)
The amount needed= this would equal to under/overhedged amount multiplied or divided by the forward rate.
Please help me clear my doubts.
Thank you.
Sorry, but I do not understand you.
The options ‘protect’ you on the amount covered by the contracts.
Because of the contract size, the amount covered by the contracts does not exactly equal the amount at risk. To protect against this amount, then you could use the forward rate.
Sorry I was confusing myself.
I understood where I went wrong.
Thank you for your help Sir.
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