Consider the following scenario: Assume that currently the spot exchange rate between the USD and the Canadian Dollar is USD1 = C$1. Assume that you (US firm) owe a payment to a Canadian trading partner in Canadian dollars in three months from now, say on February 10. Consider the following two currency options:

I. Call option on the Canadian Dollar with the strike price of C$1 = USD0.99

II. Put option on the Canadian Dollar with the strike price of C$1 = USD1.01 Both contracts expire on February 15 and are of American design.

Assume that the current price of the call contract is $0.05 per dollar, while the price of the put contract is $0.04 per dollar.

a) Which contract should you use to hedge against the currency risk in this case? Briefly Explain.

b) Which of these contracts is in the money at this point? And how much?

 
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