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Problem 16-08

In March, a derivatives dealer offers you the following quotes for June British pound option contracts (expressed in U.S. dollars per GBP):

			MARKET PRICE OF CONTRACT
Contract	Strike Price		Bid		Offer
Call	USD1.40		0.0622		0.0629
Put			0.0248		0.0255
Call	USD1.44		0.0423		0.0430
Put			0.0422		0.0429
Call	USD1.48		0.0248		0.0255
Put			0.0622		0.0629

1. Assuming each of these contracts specifies the delivery of GBP 31,450 and expires in exactly three months, complete a table similar to the following (expressed in dollars) for a portfolio consisting of the following positions:

   1. Long one 1.44 call

   2. Short one 1.48 call

   3. Long one 1.40 put

   4. Short one 1.44 put

   Do not round intermediate calculations. Round your answers to the nearest cent. Enter the net initial costs as negative values. Use a minus sign to enter negative values. If the answer is zero, enter "0".

   June USD/GBP	Net Initial Cost		Long Call 1.44 Profit		Short Call 1.48 Profit		Long Put 1.40 Profit		Short Put 1.44 Profit		Total Net Profit
   $1.36	$		$		$		$		$		$
   $1.40	$		$		$		$		$		$
   $1.44	$		$		$		$		$		$
   $1.48	$		$		$		$		$		$
   $1.52	$		$		$		$		$		$

2. Choose the correct graph of the total net profit (i.e., cumulative profit less net initial cost, ignoring time value considerations) relationship using the June USD/GBP rate on the horizontal axis.

   The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 31 .

   A.
   B.
   C.
   D.

   What is the breakeven point? Do not round intermediate calculations. Round your answer to four decimal places.

   $

   What is the nature of the currency speculation represented by this portfolio?

   The position resembles a -Select-bearbullbutterflyItem 33 spread. The purchaser of this portfolio predicts a moderate -Select-risefallItem 34 of the USD/GBP rate.

3. If in exactly one month (i.e., in April) the spot USD/GBP rate falls to 1.390 and the effective annual risk-free rates in the United States and England are 5.0% and 6.0%, respectively, calculate the equilibrium price differential that should exist between a long 1.44 call and a short 1.44 put position. (Hint: Consider what sort of forward contract this option combination is equivalent to and treat the British interest rate as a dividend yield.) Assume that exactly 2 months left to expiration of the options. Do not round intermediate calculations. Round your answer to four decimal places. Use a minus sign to enter a negative value, if any.

   $