Assume that Smith plc will need to purchase $200,000 in 90 days. A call option exists on dollars with an exercise price of £0.54, a 90-day expiration date, and a premium of £0.04. A put option exists on dollars, with an exercise price of £0.54, a 90-day expiration date, and a premium of £0.03. Smith plc plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be £0.57 in 90 days. Determine the amount of pounds it will pay for the payables, including the amount paid for the option premium.
A) £116,000
B) £114,000
C) £108,000
D) £102,000
E) £100,000

Question

Quizplus · Accepted Answer

Smith plc will exercise the call option because the expected spot rate (£0.57) is higher than the exercise price (£0.54). The total cost will be the exercise price plus the premium: ($200,000 * £0.54) + ($200,000 * £0.04) = £108,000 + £8,000 = £116,000.

Assume That Smith Plc Will Need to Purchase $200,000 in 90