FIN 417- Assignment #2 Solutions

FIN 417- Assignment #2 Solutions - CIRCLE YOUR CHOICE OF...

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CIRCLE YOUR CHOICE OF THE CORRECT ANSWERS OR FILL IN THE BLANK WITH YOUR RESPONSE. 1. From the perspective of the writer of a put option written on €62,500. If the strike price is $1.25/€, and the option premium is $1,875, at what exchange rate do you start to lose money? Rationale: Per euro, the option premium is $1,875 $0.03/ Û Û62,500 = . Since it’s a put option, the writer loses money when the price goes down, thus he breaks even at $1.25/€ – $0.03/€ = $1.22/€ 2 XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. Assume that the forward rate is the best predictor of the future spot rate. The future dollar cost of meeting this obligation using the option hedge is: Option premium = ($0.00012/¥1.00) × ¥750,000,000 = $90,000 The future value of the option premium is: = $90,000 × (1.06) = $95,400 At the expected future spot rate of $0.0092 (= 1/109), which is higher than the exercise price of $0.0086, XYZ will exercise its call option and buy ¥750,000,000 for $6,450,000 (= ¥750,000,000 × $0.0086). The total expected cost will be: = $6,450,000 + $95,400 = $6,545,400 3 Suppose a US-based firm has a receivable position for CD 10 million. In order to hedge its exchange rate exposure, would the firm use a call or a put on the CD? Would the firm buy or sell the option? The firm has a CD receivable and is concerned about a decline in the US$ value of the CD. The firm needs the right to sell the CD, which implies they need to buy a put on the CD.
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4. Find the value of a six-month call option on the spot British pound with an exercise price of $1.50 = £1 where the current value of a pound is $1.60, the interest rate available in the U.S. is r $ = 5%, the interest rate in the U.K. is r £ = 7%., the option maturity is 6 months and the volatility of the $/£ exchange rate is 30% p.a. Foreign Currency Price
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FIN 417- Assignment #2 Solutions - CIRCLE YOUR CHOICE OF...

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