The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. If you pay an option premium of $5,000 to buy this call, at what exchange rate will you break-even?

$1.58 = €1.00

Explanation:

To calculate the exchange rate breakeven point, you divide the longer-term bond figure by the shorter-term bond figure, after which you’ll do a further exponential calculation, increasing the figure to the power of one divided by the disparity in the years of the two maturities.

the solution to the question is:

$5,000 option premium on €62,500 amounts to $0.08 per euro.

With a strike price of $1.50 =€1.00 the exchange rate will have to be ($1.50+$.80), therefore $1.58 = €1.00 for you to break even.

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