Week 9-10-Tutorial Questions Answers

Tutorial Problem Set 6
Topic: Chapter 10:

Currency Options
FM303: International Finance
Week 10, Sem. 1, 2019
ANSWER ALL QUESTIONS

NOTE: In all the following problems: (i) the underlying currencies to be bought and sold are
currencies other than the Australian dollar; (ii) the exchange rates are expressed as units of
the Australian dollar per one unit of the underlying currency; and (iii) profit and loss are
measured in terms of the Australian dollar.
Question 1: A call option allows the holder to buy EUR 100 000 against the Australian dollar at an
exercise exchange rate of 1.6500 (AUD/EUR). Determine whether or not the holder will exercise
the option, and then calculate the gross payoff at the following spot exchange rates: (a) 1.6630; (b)
1.6900; and (c) 1.6380.
Question 2. A put option allows the holder to sell CHF200 000 at an exercise exchange rate of
1.1360 (AUD/CHF). Determine whether or not the holder will exercise the option, and then
calculate the gross payoff at the following spot exchange rates: (a) 1.1420; (b) 1.5100; and (c)
1.1240.
Question 3. A call option allows the holder to buy USD100 000 at an exercise exchange rate of
1.8000 (AUD/USD). If the premium paid is 0.5 Australian cents for each USD, calculate the net
payoff at the following spot exchange rates: (a) 1.8040; (b) 1.8260; and (c) 1.7870. At what
exchange rate will the holder break even?
Question 4. A put option allows the holder to sell NOK250 000 at an exercise exchange rate of
0.190 (AUD/NOK). If the premium paid is 0.4 Australian cents for each NOK, calculate the net
payoff at the following spot exchange rates: (a) 0.200; (b) 0.192; and (c) 0.180. At what exchange
rate will the holder break even?
Question 5. The following information is available at the end of December:
Spot exchange rate (AUD/USD) 1.9640

Three-month forward rate 1.9850
Price of a call option expiring at the end of March AUD0.01
Price of a put option expiring at the end of March AUD0.01
Exercise exchange rate for the call option 1.9750
Exercise exchange rate for the put option 2.0050
A forecaster has produced the following values for the AUD/USD exchange rate prevailing at the
end of March: 1.9900 with a probability of 0.6 and 1.9620 with a probability of 0.4.
(a) What will you do if you act on the basis of the higher forecast?
(b) What will you do if you act on the basis of the lower forecast?
(c) What will you do if you act on the basis of the expected value of the forecast?
1
Question 6. The following information is available:
Call contract size GBP200 000

Put contract size GBP200 000
Price of call AUD0.01
Price of put AUD0.008
Exercise exchange rate of call 2.50
Exercise exchange rate of put 2.50
Calculate the net pay-off on long call, long put and the combined position at the following spot
exchange rates: (a) 2.505; (b) 2.540; (c) 2.495; and (d) 2.480.
Question 7. The following information is available:
Call contract size CAD400 000

Put contract size CAD400 000
Price of call AUD0.01
Price of put AUD0.01
Exercise exchange rate of call 0.96
Exercise exchange rate of put 0.94
Calculate the net pay-off on short call, short put and the combined position at the following spot
exchange rates: (a) 0.99; (b) 0.97; (c) 0.95; and (d) 0.93.
Question 8. Use the information given in problem 6 to calculate the intrinsic values of the two
options at various values of the exchange rate.
~The End~
RRK/SI/2019/FM303/W9-10TUT
2
Solutions Guide
Question 1 - Solution
(a) If S  1.6630 the holder will exercise the option, buying the euro at AUD1.6500. By selling the
euro spot at 1.6630, the following gross profit will be made:
100 000  (1.6630  1.6500)  1300
(b) At 1.6900 the holder will also exercise, earning:

100 000  (1.6900  1.6500)  4000
(c) At 1.6380 the holder will not exercise, earning zero gross profit.
(a) If S  1.142 0, the holder will not exercise the option, earning zero gross profit.
(b) The same is the case at 1.1510.
(c) At 1.12140 the holder will exercise the option, making gross profit by buying the CHF spot at
AUD1.1240 and selling at AUD1.1360. The following gross profit will be made:
200 000  (1.1360  1.1240)  2400
(a) At 1.8040 the holder will exercise, buying the USD at 1.800. By selling spot at 1.8040, the
following net loss will be made:
100 000  (1.8040  1.800  0.005)  100
(b) At 1.8260 the holder will also exercise, making the following net profit:
100 000  (1.8260  1.800  0.005)  2100
(c) At 1.7870 the holder will not exercise, losing the premium. The following net loss will be
made:
100 000  0.005  500
The break-even spot rate, which produces zero net profit, can be calculated from the following
equation:
100 000  (S  1.800  0.005)  0
which gives S  1.8050 .
3
(a) At 0.200 the holder will not exercise, losing the premium. The net loss will be:
250 000  0.004  1000
(b) The same happens at 0.192.

(c) At 0.180 the holder will exercise, making net profit of:
250 000  (0.190  0.180  0.004)  1500
The break-even spot rate, which produces zero net profit, can be calculated from the following
equation:
250 000  (0.190  S  0.004)  0
which gives S  0.186 .
Solution – Question 5
(a) If the forecast is 1.9900 profit can be made by buying the US dollar forward at 1.9850 and
selling it spot in March at 1.9900. Profit can also be made by buying the call option. By exercising
the option, the US dollar can be bought at 1.9750 and sold spot at 1.9900. Gross profit from this
operation is 0.015, while net profit is 0.005.
(b) If the forecast is 1.962 profit can be made by selling the US dollar forward at 1.9850 and
buying it spot in March at 1.9620. Profit can also be made by buying the put option. By exercising
the option, the US dollar can be bought spot at 1.9620 and sold at 2.005. Gross profit from this
operation is 0.043, while net profit is 0.033.
(c) The expected value of the forecast is:
1.9900  0.6  1.9620  0.4  1.9788
Since the forecast is lower than the forward rate, profit can be made by selling the US dollar
forward and buying it spot. Profit can also be made by buying the call option and a put option.
Question 6- Solution
Net profit will be made at 2.140 and 2.08 and net loss will be made at 2.105 and 2.095. The results
are presented in the following table (profit and loss are measured in Australian dollar terms).
Exchange rate Action Long call Long put Combined

2.505 Call exercised -1000 -1600 -2600
2.540 Call exercised 6000 -1600 4400
2.495 Put exercised -2000 -600 -2600
2.480 Put exercised -2000 2400 400
4
The results are presented in the following table (profit and loss are measured in Australian dollar
terms).
Exchange rate Action Short call Short put Combined

0.97 Call exercised 0 4000 4000
0.99 Call exercised -8000 4000 -4000
0.95 None 4000 4000 8000
0.93 Put exercised 4000 0 4000
The intrinsic value of a call option is the difference between the spot exchange rate and the
exercise exchange rate if the difference is positive and zero otherwise.
The intrinsic value of a put option is the difference between the exercise exchange rate and the spot
exchange rate if the difference is positive and zero otherwise.
Hence, the intrinsic values at various values of the spot exchange rate are as follows:
Exchange rate Call Put

2.505 1000 0
2.540 8000 0
2.495 0 1000
2.480 0 4000
~The End~
RRK/SI/2019/FM303/W9-10TUT

Week 9-10-Tutorial Questions Answers

Uploaded by

Copyright:

Available Formats

Week 9-10-Tutorial Questions Answers

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Week 9-10-Tutorial Questions Answers

Uploaded by

Copyright:

Available Formats

Tutorial Problem Set 6

Topic: Chapter 10:

ANSWER ALL QUESTIONS

Spot exchange rate (AUD/USD) 1.9640

Call contract size GBP200 000

Question 7. The following information is available:

Call contract size CAD400 000

(b) At 1.6900 the holder will also exercise, earning:

(b) The same is the case at 1.1510.

which gives S  1.8050 .

(b) The same happens at 0.192.

which gives S  0.186 .

Exchange rate Action Long call Long put Combined

Exchange rate Action Short call Short put Combined

Exchange rate Call Put

You might also like