Question
Arthur Doyle at Baker Street. Arthur Doyle is a currency trader for Baker Street, a private investment house in London. Baker Street's clients are a
Arthur Doyle at Baker Street. Arthur Doyle is a currency trader for Baker Street, a private investment house in London. Baker Street's clients are a collection of wealthy private investors who, with a minimum stake of 220,000 each, wish to speculate on the movement of currencies. The investors expect annual returns in excess of 25 %. Although officed in London, all accounts and expectations are based in U.S. dollars. Arthur is convinced that the British pound will slide significantlypossibly
to $1.3200/in the coming 30 to 60 days. The current spot rate is$1.4263/.
Arthur wishes to buy a put on pounds which will yield the 25 % return expected by his investors. Which of the following put options would you recommend he purchase? Prove your choice is the preferable combination of strike price, maturity, and up-front premium expense.
Srike Price | Maturity | Premium | ||||
$ | 1.36 | / | 30 days | $ | 0.00081 | / |
$ | 1.34 | / | 30 days | $ | 0.00021 | / |
$ | 1.32 | / | 30 days | $ | 0.00004 | / |
$ | 1.36 | / | 60 days | $ | 0.00331 | / |
$ | 1.34 | / | 60 days | $ | 0.00152 | / |
$ | 1.32 | / | 60 days | $ | 0.00063 | / |
Because his expectation is for "30 to 60 days" he should confine his choices to the 60 day
options to be sure and capture the timing of the exchange rate change.
The return on investment (ROI) at the strike price of 1.36 /pound is 1108%
The return on investment (ROI) at the strike price of $1.34 /pound is 1216%
The return on investment (ROI) at the strike price of $1.32 is 100
Arthur should purchase the 60-day option at strike price $1.34
I have provided the correct answer. Please show me the process how to solve these problems.
This is what I did and got the wrong answers.
Assumptions |
| Values |
|
|
|
|
Current spot rate (US$/) |
| $1.4263 |
|
|
|
|
Expected endings spot rate in 30 to 60 days (US$/) |
| $1.3200 |
|
|
|
|
Potential investment principal per person () |
| 220,000.00 |
|
|
|
|
|
|
|
|
|
|
|
Put options on pounds |
| Put #1 |
| Put #2 |
| Put #3 |
Strike price (US$/) |
| $1.36 |
| $1.34 |
| $1.32 |
Maturity (days) |
| 30 |
| 30 |
| 30 |
Premium (US$/) |
| $0.00081 |
| $0.00021 |
| $0.00004 |
|
|
|
|
|
|
|
Put options on pounds |
| Put #4 |
| Put #5 |
| Put #6 |
Strike price (US$/) |
| $1.36 |
| $1.34 |
| $1.32 |
Maturity (days) |
| 60 |
| 60 |
| 60 |
Premium (US$/) |
| $0.00331 |
| $0.00152 |
| $0.00063 |
|
| Put #4 |
| Put #5 |
| Put #6 |
|
| Net profit |
| Net profit |
| Net profit |
Strike price |
| $1.36000 |
| $1.34000 |
| $1.32000 |
Less expected spot rate |
| (1.32000) |
| (1.32000) |
| (1.32000) |
Less premium |
| (0.00331) |
| (0.00152) |
| (0.00063) |
Profit |
| $0.03669 |
| $0.01848 |
| ($0.00063) |
|
|
|
|
|
|
|
If Sydney invested an individual's principal purely |
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in this specific option, they would purchase an |
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option of the following notional principal (): |
| 66,465,256.80 |
| 144,736,842.11 |
| 349,206,349.21 |
|
|
|
|
|
|
|
Expected profit, in total (profit rate x notional): |
| $2,438,610.27 |
| $2,674,736.84 |
| -$220,000.00 |
Initial investment at current spot rate |
| $313,786.00 |
| $313,786.00 |
| $313,786.00 |
Return on Investment (ROI) |
| 777% |
| 852% |
| -70% |
Risk: They could lose it all (full premium) |
|
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