Question 1:

Day 0 Spot Exchange Rate EUR:USD = 1.3556

A. On day 0, your analysis of the Fed's Quantitative Easing strategy leads you to conclude that the euro is about to rise dramatically. So you take $1 million of your wealth, convert it to euros at the Day 0 exchange rate, and invest it in German T-bills paying 1.75 percent annually. You have decided you will liquidate your position in one year. Calculate your 95% one-year VaR based on historic volatility. [Note 1: Treat the 1.75% yield on German T-bills as a simple interest rate with annual compounding. Note 2: The spot exchange rate today is the rate associated with Day 0, i.e., 1.3556. The one-year forward rate is currently quoted at 1.387.]

B. Now suppose that there is a one-year EUR:USD option trading on the U.S. option markets. The price of this option implies a EUR:USD volatility of 18.50%. Based on this alternative measure of volatility, what is the 95% one-year VaR on your speculative position?