Question

On December 1, 2021, Keenan Company, a U.S. firm, sold merchandise to Velez Company of Canada for 150,000 Canadian dollars (CAD). Collection of the receivable is due on February 1, 2022. Keenan purchased a foreign currency put option with a strike price of $0.97 (U.S.) on December 1, 2021. This foreign currency option is designated as a cash flow hedge. Relevant exchange rates follow:

Date Spot Rate Option Premium
1-Dec-18 $0.97 $0.05
31-Dec-18 $0.95 $0.04
1-Feb-19 $0.94 $0.03

Required:
Compute the fair value of the foreign currency option at February 1.

Answer 1

Answer:

Keenan Company (U.S.) and Velez Company (Canada)

The fair value of the foreign currency option at February 1 = $4,500.

Explanation:

a) Data and Calculations:

Value of merchandise sold to Velez Company = CAD 150,000

Collection date of the receivable = February 1, 2022

Strike price of foreign currency put option purchased by Keenan = US$0.97

Relevant exchange rates follow:

Date        Spot Rate   Option Premium

1-Dec-21       $0.97          $0.05

31-Dec-21    $0.95          $0.04

1-Feb-22      $0.94         $0.03

The fair value of the option is based on the the change that has occurred in the Spot Rates from December 1, 2021 to February = $0.03 ($0.97 - $0.94)

Therefore, the fair value = 150,000 * $0.03 = $4,500