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solution

CSL Ltd. expects to receive royalty payments of £1.25 million next month. It needs to protect these receipts against a drop in the pound, but the CFO believes that the most likely price of the pound in 30 days will be $1.6400, with an expected minimum of $1.6250 and maximum of $1.7010. CSL can buy pound put options with a strike price of $1.6612 at a premium of 2.0 cents per pound. The spot price of the pound is currently $1.6560. The option contract size is £31,250.

a. How many contracts would CSL need to protect its receipts?
b. What would be the total premium?
c. If the pound settled at its most likely value, would the CFO exercise the option?
d. Provide your rationale.
e. Calculate CSL’s net gain on the option position?
f. If the pound settled at the maximum value, would the CFO exercise the option?
g. Provide your rationale.
h. Calculate CSL’s net gain on the option position?

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