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Hemant Nahata Tutorial 3 (Individual Assignment)

Roll No. 08509 August 23, 2009

International Financial Management

1. What is meant by the terminology that an option is in-, at-, or out-of-the-money?

Option is in the money: When the option holder benefits by exercising the option. In a call option the option holder will benefit when the spot price of the underlying asset is higher than the exercise price of the underlying asset. Similarly the option holder of a put option will benefit when the spot price is less than the exercise price of the underlying asset.

Option is at the money: When the spot price of the underlying asset and the exercise price are equal, then the option holder does not gain anything by exercising the option. So the option holder may try to sell his option and recover some amount of premium provided that the premium received exceeds the brokerage amount.

Option is said to be out of money when the option holder does not gain anything by exercising the option. In case of call option if the Spot price of the underlying asset is less than the exercise price then the option will not be exercised, similarly the holder of a put option will lapse the option instead of exercising it when the spot price is higher than the Exercise price.

2. Demonstrate with examples how would you hedge a receivable and payable position using options. (Use examples out of the examples in slide)

In Ausust 2009, a Carpet exporter from Nepal purchases Raw Wool worth US$ 100,000 from New Zealand under 90 days USD T/R Loan and sells his carpets for Euro 100,000 to a German buyer under a 90 days usance L/C. the spot rate on 23rd August is as follows:

NRB rates:

Euro Buying NRs. 110.59 and USD Selling USD 78.25

If he wants to hedge his risk then on the Euro receivables he will have to cover his losses that may arise due to the depreciation of Euro against Nepali...