366 Planning and Forecasting
money at its maturity. The option contract is designed to protect the holder
against possible shrinkage in the dollar value of the Euro account receivable
that would result from a decline in the value of the Euro. In the first case,
where the spot value of the Euro did decline, then the option is exercised and
a gain of $2,500 is produced to offset the transaction loss of $2,500 on the
Euro account receivable. However, in the second case, where the spot value of
the Euro rose, the option is permitted to expire unexercised. After all, it per-
mits the sale of the Euro at $0.88 when the spot value of the Euro is $0.92.
The option contract expires without value.
Hedging a Euro receivable with a for ward contract will result in a gain
on the for ward contract when the Euro declines in value and a loss when the
Euro increases in value. These gains and losses will in turn offset the loss on
EXHIBIT 12.6 The operation of a currency option.
Expiration-date spot value of $0.84
Notional amount of the put-option contract, in Euros 62,500
Strike price of the Euro put option $0.88
Spot value of the Euro 0.84
Amount by which option is in the money .04 0.04
Contract gain $ 2,500
Initial dollar value of the Euro receivables
Accounts receivable in Euros 62,500
Times spot exchange rate $0.88
$55,000
Final dollar value of the Euro receivables
Accounts receivable in Euros 62,500
Times spot exchange rate $0.84 52,500
Transaction loss on accounts receivable $ 2,500
Expiration-date spot value of $0.92
Strike price of the Euro put option $0.88
Spot value of the Euro $0.92
The option is permitted to expire without being exercised. The contract provides the oppor-
tunity to sell the Euro for $0.88 when its value in the spot market is $0.92. It has no value
upon its expiration.
Initial dollar value of the Euro receivables
Accounts receivable in Euros 62,500
Times spot exchange rate $0.88
$55,000
Final dollar value of the Euro receivables
Accounts receivable in Euros 62,500
Times spot exchange rate $0.92 57,500
Transaction gain on accounts receivable $ 2,500