ExpertHard1 markMultiple Choice
CPA · Question 32 · Area II: Technical Accounting
A U.S. company has a receivable of 100,000 Euros (€) due in 90 days. The current spot rate is $1.10/€. The company is concerned the Euro will depreciate. To hedge this risk, the company purchases a put option on 100,000 Euros with a strike price of $1.10/€. The premium paid is $2,000. If the spot rate in 90 days is $1.05/€, what is the net cash flow from the transaction (Receivable + Option)?
A U.S. company has a receivable of 100,000 Euros (€) due in 90 days. The current spot rate is $1.10/€. The company is concerned the Euro will depreciate. To hedge this risk, the company purchases a put option on 100,000 Euros with a strike price of $1.10/€. The premium paid is $2,000. If the spot rate in 90 days is $1.05/€, what is the net cash flow from the transaction (Receivable + Option)?
Answer options:
A.
$105,000
B.
$110,000
C.
$108,000
D.
$112,000
How to approach this question
1. Calculate value of receivable at new rate. 2. Calculate payoff of option (Strike - Spot). 3. Subtract option premium.
Full Answer
C.$108,000✓ Correct
The company collects €100,000 and converts at spot $1.05 = $105,000. The put option allows selling €100,000 at $1.10. Since $1.10 > $1.05, the option is in the money by $0.05/€. Payoff = $5,000. Total Inflow = $110,000. Less Premium Paid ($2,000) = $108,000 Net.
Common mistakes
Forgetting to subtract the premium; calculating option payoff incorrectly.
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