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Hello John, hope you are doing good.
MJY BPP
I have a confusion that why in suggested solution strike price of 1.8 is not chosen. since we need to sell £ or buy $, 1.8 is better than 1.78 $/£.
Further why has he not assumed that spot on march 30, payment date, would be equal to forward, so that he may decide whether to exercise the option or not.
Even if he assumes that options are exercised isn’t there a need to close options by doing opposite of what was done earlier ?? (Total net outflow = gain/loss on options + real market transaction + premium)… Why has suggested solution not done this.???
Regards
I am away from home until the end of next week and do not have the Revision Kit with me.
For this reason I cannot answer the whole of your question (because I cannot look at the question you are asking about).
However, we certainly cannot assume that the spot on a future date will one equal to the forward rate. They. are two completely different things and there is no reason whatsoever that they should be the same.
Secondly, we do not ‘close’ options. The option gives you the right to exercise, but if you choose not to then that is the end of the matter. There is never the case of making a loss on options. The premium is payable whether or not you end up exercising the options.
I do suggest that you watch my free lectures on foreign exchange risk management, because all of this is explained in detail, with examples.
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