Case study

(a) The following options are quoted at the market:

Option Expiration Strike Price Premium

Call 1 Month Rs.48.5/$ Rs.0.30

Put 1Month Rs.48.5/$ Rs.0.05

A trader is looking at the above options and planning to adopt long strip or long strap strategy to make profit from the rupee-dollar exchange rate volatility.

You are required to:

I. Show the pay off profile and indicate break even points for strip and strap strategies in a price range of Rs 47- Rs 50 for a dollar.

II. Comment on the desirability of the above two option strategies.

(b)Consider a call option on a stock with the following parameters

Stock price: Rs210

Strike Price: Rs 220

Time to expiration: 167 days

Risk free interest rate: 10 %

Variance of annual stock returns: 20%

Compute price of the call option

ASSIGNMENT C

1. Futures contracts are:

(a) - the same as forward contracts.

(b) - standardized contracts to make or take delivery of a commodity at a predetermined place and time.

(c) - contracts with standardized price terms.

(d) - all of the above.

2. Futures prices are arrived at by:

(a) - bids and offers.

(b) - officers and directors of the exchange.

(c) - written and sealed bids.

(d) - the Board of Trade Clearing Corporation.

(e) - both (b) and (d).

3. The primary function of the Clearing Corporation is to:

(a) - prevent speculation in futures contracts.

(b) - ensure the integrity of the contracts traded.

(c) - clear every trade made at the CBOT.

(d) - supervise trading on the exchange floor.

(e) - both (b) and (c).

4. Gains and losses on futures positions are settled:

(a) - by signing promissory notes.

(b) - each day after the close of trading.

(c) - within five business days.

(d) - directly between the buyer and seller.

(e) - none of the above.

5. Speculators help to:

(a) - increase the number of potential buyers and sellers in the market.

(b) - add to market liquidity.

(c) - aid in the process of price discovery.

(d) - facilitate hedging.

(e) - all of the above.

6. Hedging involves:

(a) - taking a futures position opposite to one's cash market position.

(b) - taking a futures position identical to one's cash market position.

(c) - holding only a futures market position.

(d) - holding only a cash market position.

(e) - none of the above.

7. Margins in futures trading:

(a) - serve the same purpose as margins for common stock.

(b) - limit the use of credit in buying commodities.

(c) - serve as a down payment.

(d) - serve as a performance bond.

(e) - are required only for long positions.

8. You may receive a margin call if:

(a) - you have a long (buy) futures position and prices increase.

(b) - you have a long (buy) futures position and prices decrease.

(c) - you have a short (sell) futures position and prices increase.

(d) - you have a short (sell) futures position and prices decrease.

(e) - both (a) and (d).

(f) - both (b) and (c).

9. Margin requirements for customers are established by:

(a) - the Federal Reserve Board.

(b) - the Commodity Futures Trading Commission.

(c) - the brokerage firms, subject to exchange minimums.

(d) - the Clearing Corporation.

(e) - private agreement between buyer and seller.

10. Futures trading gains credited to a customer's margin account can be withdrawn by the customer:

(a) - as soon as the funds are credited.

(b) - only after the futures position is liquidated.

(c) - only after the account is closed.

(d) - at the end of the month.

(e) - at the end of the year.

11. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of 200,000 in three months. On June1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell 200,000 forward in three months.The spot rate of the euro on September 1 is $1.15. Graylon will receive $_________ for the euros.

A) 224,000

B) 220,000

C) 200,000

D) 230,000

12. Forward contracts:

A) contain a commitment to the owner, and are standardized.

B) contain a commitment to the owner, and can be tailored to the desire of the owner.

C) contain a right but not a commitment to the owner, and can be tailored to the desire of the owner.

D) contain a right but not a commitment to the owner, and are standardized.

13. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?

A) purchase a call option on francs.

B) obtain a forward contract to purchase francs forward.

C) sell a futures contract on francs.

D) all of the above are appropriate strategies for the scenario described.

14. If your firm expects the euro to substantially depreciate, it could speculate by _______ euro call options or _______ euros forward in the forward exchange market.

A) selling; selling

B) selling; purchasing

C) purchasing; purchasing

D) purchasing; selling

15. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:

A) $1,562.50.

B) -$1,562.50.

C) -$1,250.00.

D) -$625.00.

16. Which of the following is true?

A) The futures market is primarily used by speculators while the forward market is primarily used for hedging.

B) The futures market is primarily used for hedging while the forward market is primarily used for speculating.

C) The futures market and the forward market are primarily used for speculating.

D) The futures market and the forward market are primarily used for hedging.

17. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by:

A) selling futures in francs.

B) buying futures in francs.

C) buying franc put options.

D) buying franc call options.

18. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The premium is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)?

A) $6,875,000.

B) $7,250,000.

C) $7,000,000.

D) $6,500,000.

E) none of the above

19. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call option is $.04. The exercise price is $.81. The option will be exercised on the expiration date, if at all. If the spot rate on the expiration date is $.87, the profit as a percent of the initial investment (the premium paid) is:

A) 0 percent.

B) 25 percent.

C) 50 percent.

D) 150 percent.

E) none of the above

20. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen to weaken, it could _______ to hedge the exchange rate risk on those exports.

A) sell yen put options

B) buy yen call options

C) buy futures contracts on yen

D) sell futures contracts on yen

21. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally?

A) $74,000.

B) $84,000.

C) $75,000.

D) $85,000.

22. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1. Johnson has negotiated a non-deliverable forward contract with its bank. The reference rate is the bahts closing exchange rate (in $) quoted by Thailands central bank in 90 days. The bahts spot rate today is $.02. If the rate quoted by Thailands central bank on August 1 is $.022, Johnson will ________ $__________.

A) pay; 20,000

B) be paid; 20,000

C) pay; 2,000

D) be paid; 2,000

E) none of the above