Question12 An Australian company purchased currency put option to hedge a 300,000 Chinese Yuan (CNY) receivable. The exercise price of the option is AUD0.200/CNY with a premium of AUD0.010/CNY. The spot rate became AUD0.195/CNY at the time of maturity. Which of the following statements is true? a. The Australian company will not exercise the option, granting a net cash flow of AUD 58,500. b. The Australian company will end up with AUD 57,000 net cash flow by exercising the option. c. The Australian company will end up with AUD 60,000 net cash flow by exercising the option. d. The Australian company will not exercise the option, granting a net cash flow of AUD 55,500. ResetMaximum marks: 1 Flag question undefined

Question

BlackTom AI · Accepted Answer

We start by restating the scenario to ensure understanding: An Australian company hedges a 300,000 CNY receivable by purchasing a currency put option with a strike price of AUD 0.200 per CNY, paying a premium of AUD 0.010 per CNY. At maturity, the spot rate is AUD 0.195 per CNY.

Option by option analysis:

Option a: The company will not exercise the option, granting a net cash flow of AUD 58,500.
- If the company does not exercise, it simply converts the 300,000 CNY at the spot rate: 300,000 × 0.195 = AUD 58,500. Premium cost is irrelevant for this cash flow calculation since it only affects the overall net result when evaluating exercise vs. not exercising. However, the premium has already been paid upfront and will reduce the overall profitability of the hedge, but the stated cash flow in this option reflects the gross cash received from the spot conversion. This option correctly captures the cash flow outcome if the option is not exercised.

Option b: The Australian company will end up with AUD 57,000 net cash flow by exercising the option.
- Exercising the put gives you the right to sell CNY at the strike of 0.200 AUD per CNY. For 300,000 CNY, you would receive 300,000 × 0.200 = AUD 60,000 in exchange for the CNY, but you paid a premium of 300,000 × 0.010 = AUD 3,000. Net cash flow from exercising would be 60,000 − 3,000 = AUD 57,000. This matches the calculation for exercising when including the premium cost, so the numeric figure is correct for the net result of exercising.

Option c: The Australian company will end up with AUD 60,000 net cash flow by exercising the option.
- This would be true if there were no premium paid. The gross value from exercising is 60,000, but the premium reduces the net benefit. Therefore, 60,000 is the gross exercise value, not the net cash flow after accounting for the premium. This option ignores the cost of the premium, making it incorrect as a net cash flow value.

Option d: The Australian company will not exercise the option, granting a net cash flow of AUD 55,500.
- If the company does not exercise, the cash flow is the spot conversion of 300,000 CNY at 0.195, i.e., 58,500. A net cash flow of 55,500 would imply a different calculation that includes more than just the premium (for example, subtracting the entire premium twice or using an incorrect spot/pricing). This figure does not align with the actual mechanics of not exercising the option and does not reflect the premium in any realistic hedging scenario here.

Putting the pieces together, exercising yields a net of 57,000 after premium, whereas not exercising yields 58,500. Although exercising has intrinsic value (the strike is higher than the spot), the premium cost makes the net outcome worse than simply converting at the market rate. The comparison shows that the not-exercising path produces the higher net cash flow in this specific setup, while exercising produces a lower net cash flow due to the premium cost.

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