Choco Inc. buys chocolate from Switzerland and resells it in the U.S. It just purchased chocolate...

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Finance

Choco Inc. buys chocolate from Switzerland and resells it in theU.S. It just purchased chocolate invoiced
at SF50,000. Payment for the invoice is due in 30 days. Assume thatthe current exchange rate of the
Swiss franc is $1.00. Also assume that three call options for thefranc are available. The first option has a
strike price of $1.00 and a premium of $.03; the second option hasa strike price of $1.03 and a premium
of $.01; the third option has a strike price of $1.06 and a premiumof $.005. Choco Inc. expects a modest
appreciation in the Swiss franc.
a) (5 points) Describe how Choco Inc. could construct a bullspreadusing the first two options. What is
the cost of this hedge? When is this hedge most effective? When isit least effective?
b) (5 points) Describe how Choco Inc. could construct a bullspreadusing the first and the third options.
What is the cost of this hedge? When is this hedge most effective?When is it least effective?
c) (5 points) Given your answers to parts (a) and (b), what is thetradeoff involved in constructing a
bullspread using call options with a higher exercise price?

Answer & Explanation Solved by verified expert

4.1 Ratings (762 Votes)

a Bull spread is constructed by buying a call option with lower strike price and selling a call option with higher strike price First option has lower strike price out of the first two options So we will buy call option with strike price of 100 and sell call option with strike price of 103 The premium paid on purchasing the call option will be compensated by premium received on selling the call option Cost of the hedge premium paid premium received 003 001 002 This hedge is most effective when spot See Answer

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Choco Inc. buys chocolate from Switzerland and resells it in theU.S. It just purchased chocolate invoicedat SF50,000. Payment for the invoice is due in 30 days. Assume thatthe current exchange rate of theSwiss franc is $1.00. Also assume that three call options for thefranc are available. The first option has astrike price of $1.00 and a premium of $.03; the second option hasa strike price of $1.03 and a premiumof $.01; the third option has a strike price of $1.06 and a premiumof $.005. Choco Inc. expects a modestappreciation in the Swiss franc.a) (5 points) Describe how Choco Inc. could construct a bullspreadusing the first two options. What isthe cost of this hedge? When is this hedge most effective? When isit least effective?b) (5 points) Describe how Choco Inc. could construct a bullspreadusing the first and the third options.What is the cost of this hedge? When is this hedge most effective?When is it least effective?c) (5 points) Given your answers to parts (a) and (b), what is thetradeoff involved in constructing abullspread using call options with a higher exercise price?