A trader at Credit Suisse First Boston is speculating on the movement of the Swedish krona (SEK). She is prepared to invest US$10 million in the transaction. The current spot rate between the krona and US$ is SEK 7. 610 = US$1, while the 30-day forward rate is SEK 7. 150 = US$1.

A. If the trader at Credit Suisse First Boston believes that the Swedish krona will actually depreciate in value against the U.S. dollar, so that the spot rate will be SEK 7. 950 = US$1 at the end of 30 days, what should she do? For this part of the question, use only the trader’s view, the spot price, and the 30-day forward market price. If she is correct, how much profit will she earn from the transaction?

B. If the trader wishes to hedge her position after launching the initial strategy outlined in part A—in other words, protect against the market moving against her—she can buy one of two options, with prices as follows:

■ Put option at SEK 7. 800 = US$1.

■ Call option at SEK 7. 500 = US$1.

Prices of either put or call option are assumed to be the same at $US0.0795 million.

a. Which option should the trader buy today? Explain your reasoning. What will the end game profit be?

b. Draw a generic payoff diagram for the option that the trader should buy.

Show the strike price and break-even point. You do not actually need to know the option premium to draw the diagram.

(Prepared by Phil Uhlmann.)