A U.S. company wants to use a currency put option to hedge 10 million Danish Kro

Question

A U.S. company wants to use a currency put option to hedge 10 million Danish Krone (DKR) in accounts receivable due in six months. The premium of the currency put option with a strike price of SO, 1333 per DKR is SO.01. The spot rate at the expiration is DKR7.20 per USD. The cost of capital for the company is 10%. a) What is the net amount of USD expected to be received by the company per DKR if the time value of option premium is ignored? b) What would be the net amount USDs recieved by the company in exchange for the DKR 10 million if the time value of the option premium is incorporated?

Explanation / Answer

As Option is not favourable, company would settle the receivables at SPOT.

Net USD received= 10,000,000 X 0.138889 = 13,88,889 - 1,00,000

= $12,88,889

Future value of Premium paid

100000 + (100000 X 100/110 X 6/12) =1,45,454

Net USD received = 13,88,889-45,454

= $12,43,434

Strike Price 0.1333 USD SPOT at expiry 0.138889 USD ( 1 / 7.2 ) Premium paid 1,00,000

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