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# Derivatives and Forward Markets

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Write a memo that talks about the differences in buying a call option, selling a call option, buying a put option, and selling a put option. Please give an example of a business scenario that would be appropriate to use in each of the contracts (put and a call contract). If one were to choose to use the forward market and were to receive 100,000 Japanese yen in roughly six months, and the current exchange rate was 5 yen equalling 1 US dollar, then with that information, how many yen would one sell or buy in the forward market?

#### Solution Preview

The use of a call and put option, be it buying the options or selling the options, will depend on the scenario or situation faced by the buyer or the seller. Let us evaluate these various circumstances and understand the differences between these various options.

A call option is an option that allows the buyer to purchase an underlying security at a predetermined price in a certain future timeframe, irrespective of the current price of the security prevailing at that timeframe in the future. For example, if a person expects that the price of a certain stock or commodity will go up in the future, he will purchase a call option now, which will entitle him to purchase the stock or commodity at a predetermined price. This is also called the exercise price of the call option, irrespective of the prevailing price in the future. The timeframe is limited to the ...

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## Foreign Exchange and Derivative Market

GLOBAL FINANCE Section Two: Foreign Exchange and Derivative Market Problems
1. The \$/? exchange rate is ?1 = \$0.95, and the ?/SFr exchange rate is SFr 1 = ?0.71. What is the SFr/\$ exchange rate?
2. Suppose the direct quote for sterling in New York is 1.1110 -5.
a. How much would £500,000 cost in New York?
b. What is the direct quote for dollars in London?
4. Suppose the euro is quoted at 0.6064- 80 in London and the pound sterling is quoted at 1.6244- 59 in Frankfurt.
a. Is there a profitable arbitrage situation? Describe it.
5. As a foreign exchange trader at Sumitomo Bank, one of your customers would like spot and thirty-day forward yen quotes on Australian dollars. Current market rates are
Spot 30-day
¥101.37-85/U.S.\$1 15-13
A\$1.2924-44/U.S.\$1 20-26
a. What bid and ask yen cross rates would you quote on spot Australian dollars?
b. What outright yen cross rates would you quote on thirty -day forward Australian dollars?
c. What is the forward premium or discount on buying thirty -day Australian dollars against yen delivery?

7. In 1995, one dollar bought ¥80. In 2000, it bought about ¥110.
a. What was the dollar value of the yen in 1995? What was the yen's dollar value in 2000?
b. By what percent has the yen fallen in value between 1995 and 2000?
c. By what percent has the dollar risen in value between 1995 and 2000?

9. On Monday morning, an investor takes a long position in a pound futures contract that matures on Wednesday afternoon. The agreed-upon price is \$1.78 for £62,500. At the close of trading on Monday, the futures price has risen to \$1.79. At Tuesday close, the price rises further to \$1.80. At Wednesday close, the price falls to \$1.785, and the contract matures. The investor takes delivery of the pounds at the prevailing price of \$1.785. Detail the daily settlement process. What will be the investor's profit (loss)?
11. Suppose that DEC buys a Swiss franc futures contract (contract size is SFr 125,000) at a price of \$0.83. If the spot rate for the Swiss franc at the date of settlement is SFr 1 = \$0.8250, what is DEC's gain or loss on this contract?
12. On January 10, Volkswagen agrees to import auto parts worth \$7 million from the United States. The parts will be delivered on March 4 and are payable immediately in dollars. VW decides to hedge its dollar position by entering into IMM futures contracts. The spot rate is \$0.8947/?, and the March futures price is \$0.9002/?.
a. Calculate the number of futures contracts that VW must buy to offset its dollar exchange risk on the parts contract.
b. On March 4, the spot rate turns out to be \$0.8952/?, while the March futures price is \$0.8968/?. Calculate VW's net euro gain or loss on its futures position. Compare this figure with VW's gain or loss on its unhedged position.

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20. Suppose that three-month interest rates (annualized) in Japan and the United States are 7 percent and 9 percent, respectively. If the spot rate is ¥142:\$1 and the ninety-day forward rate is ¥139:\$1:
a. Where would you invest?
b. Where would you borrow?
c. What arbitrage opportunity do these figures present?
d. Assuming no transaction costs, what would be your arbitrage profit per dollar or dollar-equivalent borrowed?

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