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After graduation, Linda started working for City Bank of New York as a FX trader in company's trading booth. Based on market research completed for

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After graduation, Linda started working for City Bank of New York as a FX trader in company's trading booth. Based on market research completed for speculating future movements of British pounds, Linda realized that the future direction of the exchange rate of pound was uncertain under the current macroeconomic conditions of both U.S. and U.K. However, Linda also came to a conclusion that if it starts to move, it will either appreciate or depreciate substantially. In other words, Linda believes that there is approximately equal probability of the pound strengthening or weakening against U.S. dollar by a significant margin in coming months. From the currency option trading platform, Linda is looking at a call option on pounds with an exercise price of $1.35 and a premium of $0.02 and a put option with an exercise price of $1.35 and a premium of $0.03. (40pts) a. What option trading strategy can Linda use with her belief about pound's future movement? Why? (5pts) T I b. Based on simulation analysis, the possible values of pound at the expiration turned out to be $1.05, $1.25, $1.43, and $1.52. What are the potential profits for each possible future spot rate of the pound from the strategy proposed in (a)? Consider one option contract represents 31,250. (5pts) c. Given the probability of each possible values of pound at the expiration (35% ($1.05), 15% ($1.25), 15% ($1.43) and 35% ($1.52) respectively), find the expected profit from the strategy proposed in (a). (Spts) d. Express the break-event point(s) of the trading strategy in terms of option's exercise price and premium(s) and determine the break-even point(s) of the strategy proposed in (a). (5pts) e. Construct the contingency graph for strategy proposed in (a). Be specific. (5pts) f. Different from Linda's prediction, Tim, who is also in the same trading group at City, predicts that the currency would not make any substantial moves in any direction in coming months but it would rather stay close to and around strike price of the option until option expiration. What strategy can Tim choose to speculate on future movement of the pound? Why? (5pts) g. Construct the contingency graph for strategy proposed in (f). Be specific. (5pts) h. What could be a potential strategy if one believes that the currency will appreciate but by the modest amount (e.g., $1.38)? Why? Does your strategy generate a positive net profit? Assume you can also write a call option (e.g., call option with a strike price of $1.39 and premium of $0.018). (5pts) After graduation, Linda started working for City Bank of New York as a FX trader in company's trading booth. Based on market research completed for speculating future movements of British pounds, Linda realized that the future direction of the exchange rate of pound was uncertain under the current macroeconomic conditions of both U.S. and U.K. However, Linda also came to a conclusion that if it starts to move, it will either appreciate or depreciate substantially. In other words, Linda believes that there is approximately equal probability of the pound strengthening or weakening against U.S. dollar by a significant margin in coming months. From the currency option trading platform, Linda is looking at a call option on pounds with an exercise price of $1.35 and a premium of $0.02 and a put option with an exercise price of $1.35 and a premium of $0.03. (40pts) a. What option trading strategy can Linda use with her belief about pound's future movement? Why? (5pts) T I b. Based on simulation analysis, the possible values of pound at the expiration turned out to be $1.05, $1.25, $1.43, and $1.52. What are the potential profits for each possible future spot rate of the pound from the strategy proposed in (a)? Consider one option contract represents 31,250. (5pts) c. Given the probability of each possible values of pound at the expiration (35% ($1.05), 15% ($1.25), 15% ($1.43) and 35% ($1.52) respectively), find the expected profit from the strategy proposed in (a). (Spts) d. Express the break-event point(s) of the trading strategy in terms of option's exercise price and premium(s) and determine the break-even point(s) of the strategy proposed in (a). (5pts) e. Construct the contingency graph for strategy proposed in (a). Be specific. (5pts) f. Different from Linda's prediction, Tim, who is also in the same trading group at City, predicts that the currency would not make any substantial moves in any direction in coming months but it would rather stay close to and around strike price of the option until option expiration. What strategy can Tim choose to speculate on future movement of the pound? Why? (5pts) g. Construct the contingency graph for strategy proposed in (f). Be specific. (5pts) h. What could be a potential strategy if one believes that the currency will appreciate but by the modest amount (e.g., $1.38)? Why? Does your strategy generate a positive net profit? Assume you can also write a call option (e.g., call option with a strike price of $1.39 and premium of $0.018). (5pts)

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