Yukon Inc. is a US-based shipping business that operates throughout the world. In recent years, heavy demand for commodities, particularly among developing nations, has created significant opportunities for the business. To exploit these opportunities further, Yukon Inc. has agreed to purchase a new oil tanker from a German shipyard for €20.2m. The oil tanker is near completion as it was due to be sold to another business. The order, however, was recently cancelled and Yukon Inc has agreed to buy the tanker, subject to certain changes in the tanker’s specifications. The German shipyard will deliver the ship in four months’ time and Yukon Inc. must pay the full purchase price at this point.
To deal with the foreign exchange risk associated with the deal, Yukon Inc is considering the purchase of an over-the-counter option at an exercise price of €1 = $1.1345 with a premium cost of $2.50 per €100. The current spot rate is €1 = $1.1250.
Assume that in four months’ time the spot rate moves to €1 = $1.1425.
Calculate the total cost of using the over-the-counter option for hedging.