Washi Co, Sep 2018, Q17, Currency Options – Premium

Hello

I would like to clarify the treatment of the currency option premium in this question.

Washi Co is due to receive EUR 80m in six months, so it needs protection against a fall in the EUR/JPY rate. Therefore, the correct option hedge is to buy EUR put options, giving Washi the right to sell EUR at the exercise price of JPY 126 per EUR.

The examiner’s answer calculates the option hedge as follows:

EUR 80m *126 = JPY 10,080m

Premium: EUR 80m* 3.8% = JPY 304m

Net receipt: JPY 10,080m – JPY 304m = JPY 9,776m

So the examiner deducts only the premium amount.

My approach was slightly different. Since the option premium is paid now, but the EUR receipt is received in six months, I assumed that the premium should be accumulated to six months using the Japanese treasury bill yield of 1.2% per annum.

Therefore:

JPY 304m * (1 + 1.2% * 6/12) = JPY 305.824m

Then:
JPY 10,080m – JPY 305.824m = JPY 9,774.176m

My rationale was that if we are comparing all hedge outcomes at the six-month date, the premium paid today has an opportunity cost because Washi could otherwise have invested that amount in Japanese treasury bills.

Would this approach be acceptable if I clearly state the assumption that the option premium is accumulated to the six-month settlement date?

Thank you, looking forward for your advice!