On June 18, Edwards Corporation entered into a firm commitment to purchase specialized equipment from the Okazaki Trading Company for ¥80,000,000 on August 20. The exchange rate on June 18 is ¥100 = $1. To reduce the exchange rate risk that could increase the cost of the equipment in U.S. dollars, Edwards pays $12,000 for a call option contract. This contract gives Edwards the option to purchase ¥80,000,000 at an exchange rate of ¥100 = $1 on August 20. On August 20, the exchange rate is ¥93 = $1. How much did Edwards save by purchasing the call option (answers rounded to the nearest dollar)?
A) $12,000
B) $48,215
C) $60,215
D) Edwards would have been better off not to have purchased the call option.

Question

Quizplus · Accepted Answer

The call option allowed Edwards to purchase ¥80,000,000 at an exchange rate of ¥100 = $1 on August 20. Without the call option, Edwards would have had to purchase ¥80,000,000 at the spot rate of ¥93 = $1 on August 20, which would have cost $860,215. With the call option, Edwards was able to purchase ¥80,000,000 at an exchange rate of ¥100 = $1, which cost $800,000. Therefore, Edwards saved $60,215 by purchasing the call option.

On June 18, Edwards Corporation Entered into a Firm Commitment