Chapter_5_Q_A

Chapter_5_Q_A - Chapter 5 Currency Derivatives Suggested...

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Currency Derivatives Suggested Homework Questions (updated 8/8/06) 1. The current 90-day forward rate for Swiss francs is $1.25/SF and you are sure the spot rate will be $1.30 three months (90 days) from now. What could you do with $2,000 to profit from this situation? (Explain the steps you would take today and 90 days from today assuming the spot rate 90 days from now actually is $1.30/SF.) Today Step 1: Enter into a forward contract to buy $2,000 ÷ $1.25/SF = SF1,600 in 90 days at a rate of $1.25/SF 90 Days Step 1: Honor contract: buy SF1,600 at a cost of (1,600)($1.25) = $2,000 Step 2: Sell SF1,600 in the spot market at an exchange rate of $1.30/SF and receive (1,600)($1.30) = $2,080 Profit : $2,080 – $2,000 = $80 2. Suppose the current 180-day forward rate for German euros is $1.50/ and general expectations are that the spot rate in 180 days will be $1.45/ . What is likely to happen to the 180-day forward rate in the market place and why will it happen? Because the E(S 180 ) is anticipated to be lower than the current forward rate, most people will decide not to buy euros forward but instead will want to sell euros forward at $1.50/€. Since more people are trying to sell euros at the current forward rate than are trying to buy euros, today’s forward rate will begin to decrease until it equals the market’s anticipated future spot rate, i.e. E(S 180 ) = F 180 = $1.45/€. 3. Suppose today's rates for the Canadian dollar are as follows: spot rate $0.65/CD, 30-day forward rate $0.67/CD, 90-day forward rate $0.70/CD, and 180-day forward rate $0.62/CD. What is the market anticipating the value of the US dollar to do over the next six months? The is anticipating that the value of the dollar will decrease over the next 90 days and then to increase for the next 90 days to above today’s value 4. Suppose the current spot rate for the British pound is $1.56/£ and the premium is 2¢ for a May Call Option with a strike price of $1.525. There are £62,500 in each option. Describe the steps you would take in order to make a profit under these conditions. What is the financial term for this type of activity? Step 1: Buy a May call for pounds at a cost of $.02/pound => 62,500(0.02) = $1,250 Step 2: Exercise the call immediately; receive £62,500 at a cost of $1.525/pound => 62,500(1.525) = $95,312.50 Step 3: Sell pounds high in the spot market at a rate of $1.56/pound => 62,500(1.56) = $97,500 Profit: $97,500 - $1,250 - $ 95,312.50 = $937.50 This is called arbitrage – making a profit with no risk 5. Consider a Call Option with a strike price of $0.70/€ and a premium of 5¢/€. Draw the Contingency Graph for the buyer of this Call. - 5¢
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Chapter_5_Q_A - Chapter 5 Currency Derivatives Suggested...

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