WEEK 3

Ex 14 (Ex 3)

Using the quotations in Exhibit 6.3, calculate the face values of the open interests in the June 2010 and
September 2010 Euro/Japanese yen futures contracts.

Solution:

June: 7,309 contracts x 125,000 = 913,625,000,

September: 527 contracts x 125,000 = 65,875,000.

Ex 15 (Ex 4)

Using the quotations in Exhibit 6.3, note that the September 2010 Mexican peso futures contract has a price of
$0.77275 per 10 MXN. You believe the spot price in September will be $0.83800 per 10 MXN. What
speculative position would you enter into to attempt to profit from your beliefs? Calculate your anticipated
profits, assuming you take a position in three contracts. What is the size of your profit (loss) if the futures price
is indeed an unbiased predictor of the future spot price and this price materializes?

Solution:

You expect MXN to appreciate more than Future implies. Go long MXN to buy them cheap.

Nominal value of each contract: 500,000 MXN You will buy 1,5 mln MXN

It will cost 3 X 500,000 X 0.077275 = 115,912.5 $

You expect you can sell them for 3 X 500,000 X 0,083800 = 125,700 $

You get a profit of : 125,700 115,912.5 = 9,787.5 $

If Spot price=Future price no profit

Ex 16 (Ex 5)

Do problem 4 again assuming you believe the September 2010 spot price will be $0.70500 per 10 MXN.

Solution

You expect MXN to be cheaper than expected, so you go short in the future contract

3 x ($0.077275 - $0.070500) x MXN500,000 = $10,162.50

Ex 17 (Ex 6)

Using the market data in Exhibit 6.6, show the net terminal value of a long position in one 108 Jun Japanese
yen European call contract at the following terminal spot prices (stated in U.S. cents per 100 yen): 104, 106,
108, 110, and 112. Ignore any time value of money effect.
1
Solution:

You have a call option on Yen: right to buy Yen at 108. You gain if by the expiration day Yen are more expensive
than that

Strike price: 108 $c/100 Y

Call price = 1.55/100 $c for each Y

Contract size: 1,000,000 Y

The net terminal value of one call contract is:

[Max[ST E, 0] Ce] x JPY1,000,000/100 100, where JPY1,000,000 is the contract size of one JPY contract.

At 104: ([Max[104 108, 0] 1.55] x JPY1,000,000)/100 100 = -$155

At 106: [Max[106 108, 0] 1.55] x JPY1,000,000/100 100 = -$155

At 108: [Max[108 108, 0] 1.55] x JPY1,000,000/100 100 = -$155

At 110: [Max[110 108, 0] 1.55] x JPY1,000,000/100 100 = $45

At 112: [Max [112 108, 0] 1.55] x JPY1,000,000/100 100 = $245

Ex 18 (Ex 7)

Using the market data in Exhibit 6.6, show the net terminal value of a long position in one 108 Jun Japanese
yen European put contract at the following terminal spot prices (stated in U.S. cents per 100 yen): 104, 106,
108, 110, and 112. Ignore any time value of money effect.

Solution:

The net terminal value of one put contract is:

At 104: [Max[108 104, 0] 0.98] x JPY1,000,000/100 100 = $302

At 106: [Max[108 106, 0] 0.98] x JPY1,000,000/100 100 = $102

At 108: [Max[108 108, 0] 0.98] x JPY1,000,000/100 100 = -$98

At 110: [Max[108 110, 0] 0.98] x JPY1,000,000/100 100 = -$98

At 112: [Max[108 112, 0] 0.98] x JPY1,000,000/100 100 = -$98

Ex 19 (Ex 8)

Assume that the euro is trading at a spot price of $1.49/. Further assume that the premium of an

2
American call (put) option with an exercise price of $1.50 is 1.55 (3.70) cents. Calculate the intrinsic
value and the time value of the call and put options.

Solution:

Intrinsic value: in time t: what you get exercising in t

Time value: difference between market value and intrinsic value

Call: Intrinsic value = Max[ST E, 0] = Max[1.49 1.50, 0] = 0

Time Value = Premium - Intrinsic Value = 1.55 0 = 1.55 cents

Put: Intrinsic value = Max[E - ST, 0] = Max[1.50 1.49, 0] = 1 cent

Time Value = Premium - Intrinsic Value = 3.70 1 = 2.70 cents

Ex 20 (Ex 9)

Assume spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950. What is the minimum
price that a six-month American call option with a striking price of $0.6800 should sell for in a rational
market? Assume the annualized six-month U.S. dollar interest rate is 3 percent.

Solution:

R= 3.5% /2 = 1.75%

1) If you use the call option today 0.7 0.68 = 2 cents

2) If you wait, must give you in the future at least what a forward contract would: (0.6950 0.68);
the PV is thus (0.6950 0.68)/1.0175 = 1.47 cents
3) Cannot have negative value

Ex 21 (Ex 10)

Do problem 9 again assuming an American put option instead of a call option.

Solution: Pa Max[(68 - 70), (68 - 69.50)/(1.0175), 0]

3
 Max[ -2, -1.47, 0] = 0 cents

Ex 22 (Ex 11)

Use the European option-pricing models developed in the chapter to value the call of problem 9 and
the put of problem 10. Assume the annualized volatility of the Swiss franc is 14.2 percent. This
problem can be solved using the FXOPM.xls spreadsheet.

Solution:

D1 = ln(Ft/X) + * VAR * T / DEV.ST*rad.q(T)

d1 = [ln(69.50/68) + .5(.142)2(.50)]/(.142).50 = .2675

D2 = d1 Dev.St.* rad.q(T)

d2 = d1 - .142.50 = .2765 - .1004 = .1671

N(d1) = .6055

N(d2) = .5664

N(-d1) = .3945

N(-d2) = .4336

C = [N(d1)*F N(d2) X]* e^(-r*T)

P = [X*N(-d2) F*N(-d1)]*e^(-r*T)

Ce = [69.50(.6055) - 68(.5664)]e-(.035)(.50) = 3.51 cents

Pe = [68(.4336) - 69.50(.3945)]e-(.035)(.50) = 2.03 cents

Ex 23 (Ex 12)
Use the binomial option-pricing model developed in the chapter to value the call of problem 9.
The volatility of the Swiss franc is 14.2 percent.

4
Solution:

S0 = 0.7 $

T=1/2 (6 months)

Sigma= 0.142

X = 0.68 $

F = 0.695 $

R = 1.75%

The spot rate in t=T will be either u*S0 or d*S0 where u= e.142.50 = 1.1056 and d = 1/u = .9045

0.7739 = 0.7 X 1.1056

0.6332 = 0.7 X 0.9045

Case 1: 0.7739 0.68 = 0.0939 $

Case 2: 0 (call option not exercised)

Alternatively, you can lock-in a Forward rate of 0.695

With risk-neutral investors it must be that q*S0u + (1-q)S0d = F q= (F S0d)/S0(u-d) = 43.92%

Conversely, the risk-neutral probability 1-q is 56.08%

A call option thus gives you in t=T 0.0939 $ wth prob. 43.92% or 0 with prob. 56.08%

Its value is: (0.4392 X 0.0939)/(1 + 0.0175) = 0.040555827

Alternative method

Cu + h(S0u) = Cd + h(S0d) h= (Cu Cd)/S0(u d)

The hedge ratio is h = (9.39 0)/(77.39 63.32) = .6674.

5
{Fh X[(S0u/X)(h-1)+1]}/(1+r)
69.50(.6674) 68((0.7739/68)(.6674 1) +1)]/(1.0175) = 0.040555827
!!!! since its American, the price could also be S-X = 0.02. Check whats higher!