(Scenario-3)If the spot price is higher than the strike price at the time of maturity,the buyer stands to gain

in exercising the option. The buyer can buythe underlying asset at strike price and sell the same at currentmarket price thereby make profit.However, it may be noted that if on maturity the spot price is less thanthe INR 43.52 (inclusive of the premium) the buyer will stand to loose.CURRENCY OPTIONSA currency option is a contract that gives the holder the right (but notthe obligation) to buy or sell a fixed amount of a currency at a givenrate on or before a certain date. The agreed exchange rate is known asthe strike rate or exercise rate.An option is usually purchased for an up front payment known as apremium. The option then gives the company the flexibility to buy orsell at the rate agreed in the contract, or to buy or sell at market ratesif they are more favorable, i.e. not to exercise the option. How are Currency Options are different from ForwardContracts ? A Forward Contract is a legal commitment to buy or sell a fixedamount of a currency at a fixed rate on a given future date. A Currency Option, on the other hand, offers protection againstunfavorable changes in exchange raters without sacrificing thechance of benefiting from more favorable rates. Types of Options : A Call Option is an option to buy a fixed amount of currency. A Put Option is an option to sell a fixed amount of currency. Both types of options are available in two styles :1. The American style option is an option that can be exercisedat any time before its expiry date.2. The European style option is an option that can only beexercised at the specific expiry date of the option.

Option premiums : By buying an option, a company acquires greater flexibility and at thesame time receives protection against unfavorable changes inexchange rates. The protection is paid for in the form of a premium.Example :A company has a requirement to buy USD 1000000 in one monthstime.Market parameters :Current Spot Rate is 1.600, one month forward rate is 1.6000 Solutions available :

Do nothing and buy at the rate on offer in one months time. Thecompany will gain if the dollar weakens (say 1.6200) but willlose if it strengthens (say 1.5800). Enter into a forward contract and buy at a rate of 1.6000 forexercise in one months time. In company wil gain if the dollarstrengthens, but will lose if it weakens. But a call option with a strike rate of 1.6000 for exercise in onemonths time. In this case the company can buy in one monthstime at whichever rate is more attractive. It is protected if thedollar strengthens and still has the chance to benefit if itweakens. How does the option work ? The company buys the option to buy USD 1000000 at a rate of 1.6000on a date one month in the future (European Style). In this example,lets assume that the option premium quoted is 0.98 % of the USDamount (in this case USD 1000000). This cost amounts to USD 9800or IEP 6125. Outcomes : If, in one months time, the exchange rate is 1.5000, the cost of buying USD 1000000 is IEP 666,667. However, the companycan exercise its Call Option and buy USD 1000000 at 1.6000.So, the company will only have to pay IEP 625000 to buy theUSD 1000000 and saves IEP 41667 over the cost of buyingdollars at the prevailing rate. Taking the cost of the potion premium into account, the overall net saving for the companyis IEP 35542. On the other hand, if the exchange rate in one months time is1.7000. The company can choose not to exercise the CallOption and can buy USD 1000000 at the prevailing rate of 1.7000. The company pays IEP 588235 for USD 1000000 andsaves IEP 36765 over the cost of forward cover at 1.6000. Thecompany has a net saving of IEP 30640 after taking the cost of the option premium into account.In a world of changing and unpredictable exchange rates, thepayment of a premium can be justified by the flexibility thatoptions provide