Kelly plc is an MNC based in Scotland that has bid on a project sponsored by the Canadian government. If the bid is accepted, Kelly will need approximately C$1,500,000 to purchase Canadian materials and services. However, Kelly will not know whether the bid is accepted until 3 months from now. Kelly is uncertain about the value of the Canadian dollar in the next 3 months. If currency rises above a certain level the project will no longer be profitable. The current spot rate for the Canadian dollar is £0.42 Kelly can purchase call options with 3-month expiration date that will guarantee a minimum level of profit from the project if the bid is successful. Ten call options will cover the entire amount of potential exposure. The strike price or exercise price on the Canadian dollar is £0.43 and the call option premium is £0.004 per unit.
a) What is the maximum amount needed to purchase the C$1,500,000?
b) How much will Kelly lose if it buys this call option and its bid is unsuccessful?
c) If it wins, how much will it spend on material?
d) If the Canadian dollar is £0.44 in three months, should Kelly exercise the option? Explain.
e) Consider the following alternative available to Kelly plc. It can purchase
C$1,500,000 from its bank in three months at a forward rate of £0.425. The penalty for breach this forward contract is £1400. Should Kelly plc purchase the call or use this forward contract? Explain