Question

A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year the U.S. firm gets paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60,

Answer 1

Answer:

The firm will realize $1,640,000 on the sale net of the cost of hedging.

Explanation:

Answer 2

Answer:

Since the US company paid $0.01 per euro for the put option, they will receive ($1.65 - $0.01) x 1,000,000 = $1,640,000 when they execute their option. That will result in a net gain of $1,640,000 - $1,600,000 (the current exchange rate) = $40,000. Since the exchange rate was lower than the put option rate, the company was able to make a gain.

Explanation: