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# Exchange Rate

1) The premium on a pound call and put option is \$.03 per unit. The exercise priceis \$1.60. What are the break even points for the buyer of the call option and for the buyer of the put option? (Assume zero tranasactions cost and that the buyer and seller of the put option are speculators).

2) Assume the bid rate of a new Zealand dollar is \$.33 while the ask rate is \$.335 at Bank X. Assume the bid rate of the New Zealand dollar is \$.32 while the ask rate is \$.325 at Bank Y. Given this information, what would be your gain if you use \$1,000,000 and excute locational arbitrage.

3) Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the Mexican five-year interest rate is 8% annualized. Today's spot rate of the Mexican peso is \$.20 . What is the approximate five-year forecast of the peso's spot rate if the five-year forward rate is used as a forecast?

4) Assume the following information:

Spot Rate today of Swiss franc = \$.60
1-year forward rate as of today for Swiss franc = \$.63
Expected spot rate 1-year from now = \$.64
Rate on 1-year deposits denominated in Swiss francs = 7%
Rate on 1-year deposits denominated in US dollars = 9%

From the perspective of US invetors with \$1,000,000, what would be rate of return under covered interest arbitrage?

#### Solution Preview

1) The premium on a pound call and put option is \$.03 per unit. The exercise priceis \$1.60. What are the break even points for the buyer of the call option and for the buyer of the put option? (Assume zero tranasactions cost and that the buyer and seller of the put option are speculators).

A call option is exercised when the asset price increases beyond the exercise price
A put option is exercised when the asset price decreases beyond the exercise price

Breakeven point for buyer of call option= Exercise price + premium= \$1.63 =1.6+0.03
Breakeven point for buyer of put option=Exercise price - premium= \$1.57 =1.6-0.03

2) Assume the bid rate of a new Zealand dollar is \$.33 while the ask rate is \$.335 at Bank X. Assume the bid rate of the New Zealand dollar is \$.32 while the ask rate is \$.325 at Bank Y. Given this information, what would be your gain if you use \$1,000,000 and excute locational arbitrage.

Bid rate is the rate at which you can sell NewZealand dollar

#### Solution Summary

Answers questions on Call and Put Options, Locational arbitrage, Interest rate parity, Coverage Interest Arbitrage.

\$2.19