The DKNY Corporation owes Mex$ 7 million due for payment to the Mexican supplier
ID: 2758568 • Letter: T
Question
The DKNY Corporation owes Mex$ 7 million due for payment to the Mexican supplier in 30 days. The current spot-rate is Mex$ 13.00/USD. DKNY has decided to to hedge the Mexican peso exposure by the use of a put-option on USD or currency collar (range forward) contract with CitiBank as counterparty. Currently, a 30-day put-option on USD at exercise rate 12.9 (Mex$ 12.9/USD) trades at a 1% premium, while a 30-day call-option on USD at exercise rate 13.1 (Mex$ 13.1/USD) trades at a 3% premium.
What is the hedged cost of DKNY’s payables using a put option? State your answer to the nearest USD (e.g. 543,210 or 678,910)!
Explanation / Answer
By buying a put option, DKNY can lock the cost $548,020.3by adding the 1% put premium i.e. 0.01 x 7,000,000 /13 = $5,384.62 and 7,000,000/12.9 = $542,635.7 cost of buying pesos using a put option at a rate of Mex$12.9/$. The put option gives DKNY the option to buy pesos in the spot market in 30 days if the spot rate of the dollar is greater than the exercise price of Mex$12.9/$. Hence, the $548,020 cost if the maximum cost of using a put option.
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