Question Number Two

1. On July 1, 2008, a company enters into a forward contract to buy 10 million Japanese yen on January 1, 2009. On September 1, 2008, it enters into a forward contract to sell 10 million Japanese yen on January 1, 2009. Describe the payoff from this strategy. (2)
2. Suppose that USD/Sterling spot and forward exchange rates are as follows:

Spot Rate	$2.0080 per
90-day forward rate	$2.0056 per
180-day forward rate	$2.0018 per

Requirement:

What opportunities are open to an arbitrageur in the following situations?

1. A 180-day call option to buy 1 for $1.97 costs 2 cents. (2)
2. A 90-day put option to sell 1 for $2.04 costs 2 cents. (2)

3. The price of gold is currently $600 per ounce. The forward price for delivery in 1 year is $800. An arbitrageur can borrow money at 10% per annum. What should the arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no income. (2)
4. You would like to speculate on a rise in price of a certain stock. The current stock price is $29 & a 3-month call with a strike price of $30 costs $2.9 (option price). You have $5,800 to invest. Identify two alternative investment strategies, one in the stock and the other in an option on the stock. What are the potential gains and losses from each? You can assume some future spot prices and illustrate the gains and losses with the help of diagrams. (2)