A U. S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally?

Answer: $36,400

Explanation:

Given the following;

Premium price = $0.02

Exercise price = $0.5

Amount (pound payable) payable = $70,000

Therefore, total amount will be the sum of the actual amount when the option is being exercised and the amount paid as premium.

Therefore,

Amount paid on exercised option = dollar payable * exercise price

Amount paid on exercise option = 70000 * 0.5 = $35,000

Amount paid as premium = dollar payable * premium price

Amount paid as premium = 70000 * 0.02 = $1,400

Therefore total amount paid = $35,000 + $1,400 = $36,400