I’m having a really hard time figuring out this problem. Its a practice problem for my upcoming final and would really appreciate a step-by-step example to study off from.
International Finance (Final Practice Problem):
Boeing imported a Rolls-Royce jet engine for £10 mil payable in one year.
– The US interest rate 3.00% per annum
– The UK interest rate 3.25% per annum
– The Spot exchange rate $ 1.80/£
– The Option strike price $1.70/£ (option matures in one year)
– Option premium is $0.02/£
If Boeing decides to use options to hedge the foreign exchange exposure, which type of options should the company use, put or call? Also,
How exactly should the company execute the hedging through options? To answer this question, please calculate the company’s US dollar cost when the spot rate at maturity is $1.30/£, $1.70/£, and $2.00/£.