Futures and Options

1. Explain the difference between foreign currency options and futures and when either might be used most appropriately (2points).

2. Steve Smith trades currencies in Hong Kong.His main responsibility is to manage the dollar/Singapore $ ($/S$) trading desk.Suppose that the current spot rate is $.60/S$.Steven believes that the Singapore dollar is about to appreciate against the US dollar in the next 90 days.He expects the rate to move to $.70/S$.(4 points)

The following options are available:

Option Exercise Price Premium

Put on S$ $.65/S$ $0.00003/S$

Call on S$ $.65/S$ $0.00046/S$

One option contract contains S$10,000.

a. In your estimation, should Steve buy a call or a put given his expectations?

b. Given your choice in a), graph the payoff diagram and identify the breakeven price.

c. Calculate Steven's profit if the spot rate in 90 days is .60, .65, .70, .75, .80.

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3. Jillian Mayfield, a currency trader in Chicago, uses the following quotes to speculate on the British pound in the futures market.

The contract size is 62,500 pounds.

Maturity Open High Low Settle Change Open Interest

MJo4C UP.D9uD9 YH.cyRNe kS.91u2g jP.yaxLw E

June 1.4164 1.4188 1.4146 1.4162 .0030 809

a. If Jillian buys 5 June pound futures, and the spot rate at maturity is $1.398/, what is the value of her position?

b. If Jillian sells 12 March pound futures, and the spot rate at maturity is $1.456/, what is the value of her position?

c. If Jillian buys 3 March pound futures, and the spot rate at maturity is $1.456/, what is the value of her position?

d. If Jillian sells 12 June pound futures, and the spot rate at maturity is $1.398/, what is the value of her position?

4. Answer the following:

a. You read that exchange-traded American call options on euros having a strike price of 1.46 and a maturity of next March are now quoted at 3.67.What does this mean if you are a potential buyer?

b. What happens to the premium you paid for the option in a) if you let the option expire unexercised?What happens to the premium if you decide to exercise the option?

c. You have the same information as in a), expect the option is a European option.What is different?

d. Why would anyone write an option knowing that the gain from receiving the option premium is fixed but the loss if the underlying price goes in the wrong direction can be very large?