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.)
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
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
: $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
) 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
) = F
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) =
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.