Futures and Options on Foreign Exchange

The correct answer for each question is indicated by a 1 CORRECT A call option .

is a contract to buy a certain quantity of a specific underlying asset at a specific price at a specified date in the future. A) gives the holder the right, but not the obligation, to sell the underlying asset for a stated price over a stated time B)period. is an exchange-traded contract to buy a certain quantity of a specific underlying asset at a specific price at a specified C)date in the future. gives the holder the right, but not the obligation, to buy the underlying asset for a stated price over a stated time D)period. Feedback: Correct! 2 CORRECT Consider a put option written on 100,000. The strike price is $1.50 = 1.00 and the option premium is $0.02 per euro. What is the theoretical maximum gain on this position? There is unlimited upside potential. A)

$80,000 B)

$148,000 C)

$2,000 D) Feedback: Correct! 3 CORRECT Consider a trader who opens a short futures position. The contract size is 62,500, the maturity is six months, and the initial price is $1.50 = 1. The next day, the settlement price is $1.60 = 1. What is the amount of the trader's gain or loss? Gain of $6,250. A)

Loss of $6,250. B)

Gain of $2,604. C)

No gain or loss, since maturity has not arrived. D) Feedback: Correct! 4 CORRECT Consider a trader who buys a European call option on euro. The contract size is 62,500, the maturity is six months, and the strike price is $1.50 = 1. At maturity, the settlement price is $1.60 = 1. What is the amount of the trader's gain or loss? Gain of $6,250.

A)

Loss of $6,250. B)

Gain of $2,604. C)

No gain or loss, since expiry has not arrived. D) Feedback: Correct! 5 INCORRECT You have a call option on 10,000. Maturity is one year; the risk-free rate in dollars is 5% per annum. The euro is worth $1.50 today and in one year the euro will be worth either $1.60 or $1.40. The exercise price of the option is $1.50/. The one-year forward exchange rate is $1.55/. Use the binomial option pricing model to estimate the value of the call option described above. $0 A)

$714.29 B)

$476.19 C)

$13.64 D) Feedback: The correct equation is q = .75 = (1.55 1.40)/(1.60 1.40); C0 = [(.75$.10/110,000 + .25$0)/1.05, = $714.29/. 6 INCORRECT You have a call option for which maturity is one year and the risk-free rate in dollars is 5% per annum. In one year the euro will be worth either $1.60 or $1.40. The exercise price of the option is $1.50/. The one-year forward exchange rate is $1.55/. Calculate the hedge ratio for the call option described above. 0.50 A)

2.00 B)

2.20 C)

0.75 D) Feedback: The correct equation is h = (Cut Cdt)/S0(u d) = ($.10 - $0)/($1.60 1.40) = 0.50. 7 CORRECT For two otherwise-identical put options, the more valuable one will have a lower strike price. A) higher strike price.

B)

larger St. C)

larger r$. D) Feedback: Correct! 8 INCORRECT You have a six-month call option on Japanese yen. The strike price is $1 = 100. The volatility is 25 percent per annum; r$ = 5.5% and r = 6%. Use the European option pricing formula to find the value of the call option described above. $0.005395/ A)

$0.005982/ B)

$0.006137/ C)

None of the above. D) Feedback: The correct process is as follows:

Note: N(d) was calculated using NORMSDIST in Excel. 9 CORRECT Suppose you wish to speculate on a rise in the value of the euro. If you are correct and the value of the euro does indeed rise in the future, you would profit with a short position in a futures contract on the euro. A)

a long position in a futures contract on the euro. B)

a short position in a forward contract on the euro. C)

None of the above. D) Feedback: Correct!

10 CORRECT Consider a put option written on 100,000. The strike price is $1.50 = 1.00 and the option premium is $0.02. At what exchange rate will the buyer of this put option break even? $1.00 = .667 A)

$1.52 = 1.00 B)

$1.48 = 1.00 C)

$1.50 = 1.00 D)