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Dear Sir,
I am reading the example on page 450 Study text (BPP) about currency option & summarize the question and answer in the book as below:
A UK company owes US supplier $2,000,000 payable in July. Spot rate in July is 1.46 – 1.462. From the given information, UK Co needs to hedge 41.97 contracts ~ 42 contracts.
the result of the exercise option (42 contracts) $2,001,563
Value of transaction $2,000,000
Balance $1,563
Translate at spot rate ($1,563/1.46) = £1,071
My question: After the exercise option and payment to supplier, we have $,1,563. We need to convert this $ to £ and calculate the total cost in £. My calculation in this case is 1,563/1.462 = £1,069. Why do they use 1.46 in the book for this calculation?Thanks,
DTI do not have the BPP Study Text.
However, although you would normally convert the receipt at 1.462 (and you would not lose marks if you did) it would make more sense to use the receipt as part of the payment to the supplier (which would then effectively be converting it at 1.46).
(I do mention this in my free lecture on currency options)
Thanks Sir. This is the cash balance after we pay to supplier. When we convert this $1,563 to £ , I understand we sell this $ to the bank and in the real life, the bank will use 1.462. I hope my thinking makes more sense in real life and of course in the exam. Please advise if any error in my above idea.
Thanks
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