Question 1: Which of the following is NOT true for the writer of a put option?
a. the maximum loss is limited to the strike price of the underlying asset less the premium.
b. the gain or loss is equal to but of the opposite sign of the buyer of a put option
c. the maximum gain is the amount of the premium
d. all of the above are true
Question 2: Plains estates manufacturing has just signed a contract to sell agricultural equipment to boschin, a German firm, for E (euro) 1,250,000. The sale was made in June with payment due six months later in December. Because this is sizable contract for the firm and because the contract for the firm and because the contract is in euros rather than dollars, plains states is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
- The spot exchange rate is $0.8924/E
- The 6 month forward rate is $0.8750/E
- Plains states cost of capital is 11%
- The euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
- The euro zone 6-month lending rate is 7 % ( or 3.5 % for 6 months)
- The u.s. 6-month borrowing rate is 8% (or 4% for 6 months)
- The us 6-month lending rate is 6% (or 3% for 6 months)
- December put options for E625,000; strike price $0.90, premium price is 1.5%
- Plains states forecast for 6 month spot rates is $0.91/E
- The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $0.86/E
A _____ hedge allows plains states to enjoy the benefits of a favorable change in exchange rates for their euro recievables contract while protecting the firm from unfavorable exchange rate changes.
a. forward
b. call option
c. put option
d. money market