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Puts and Calls

Task 3a: Problem Set

Directions: Type your answer to each question where indicated. Use more space if needed.

1. On Monday morning, an investor takes a long position in pound futures contract that matures on Wednesday afternoon. The agreed-upon price is $1.78 for 62,500 pound sterling. 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 (refer to exhibit 8.3). What will be the investor's profit (loss)?

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2. The 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 SFr1 = $0.8250, what is DEC's gain or loss on this contract?

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3. Assume that the spot price of the British pound is $1.55, the annualized 30-day sterling interest rate is 10%, the annualized 30-day U.S. interest rate is 8.5%, and the annualized standard deviation of the dollar:pound exchange rate is 17%. Calculate the value of a 30-day PHLX call option on the pound at a strike price of $1.57.

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4. On August 6, you go long one IMM yen futures contract at an opening price of $0.00812 with a performance bond of $4,590 and a maintenance performance bond of $3,400. The settlement prices for August 6, 7, and 8 are $0.00791, and $0.00845, and $0.00894, respectively. On August 9, you close out the contract at a price of $0.00857. Your round-trip commission is $31.48.

a. Calculate the daily cash flows on your account. Be sure to take into account your required performance bond and any performance bond calls.

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b. What is your cash balance with your broker on the morning of August 10?

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5. On June 25, the call premium on a December 25 PHLX contract is 6.65 cents per pound at a strike price of $1.81. The 180-day interest rate is 7.5% in London and 4.75% in New York. If the current spot rate is 1 pound sterling = $1.8470 and the put=call parity holds, what is the put premium on a December 25 PHLX pound contract with an exercise price of $1.81?

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Currency Derivatives Framework
Forward and Futures Contracts
A forward contract is a contract between a multinational corporation and a financial institution to exchange a specified amount of currency on a specific date at a specific exchange rate. By doing so, multinational corporations lock in the exchange rate for delivery of currency in future.
A futures contract is a standardized contract between a multinational corporation and a futures exchange to exchange a specified amount of currency on a specific date at a specific exchange rate. A futures contract is a promise, although less than 1 percent of futures contracts are delivered.
Multinational corporations use futures and forward contracts for hedging purposes. Speculators use futures contracts to make money on exchange rate movements (arbitrage).
The currency premium or discount is related to forward rates (Unit 1).
Currency Options
A call option is a right to buy a specific currency at a specified price (rate) within a specific time period. A put option is a right to sell a specific currency at a specified price (rate) within a specific time period. The specific price is known as "exercise price" or "strike price." Buying an option is known as the "long position," and selling an option is known as the "short position"; the seller is called the "writer."
Keep the following points in mind for call options and put options:
A call option is
? in-the-money if the spot exchange rate exceeds the strike rate
? out-of-the-money if the spot exchange rate is less than the strike rate
? at-the-money if the spot rate is equal to the strike rate
A put option is
? in-the-money if the spot exchange rate is less than the strike rate
? out-of-the-money if the spot exchange rate is more than the strike rate
? at-the-money if the spot rate is equal to the strike rate
The price of an option is known as the "premium."
There are four basic strategies in the options market:
1. Long call
2. Short call
3. Long put
4. Short put

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Time Action Cash Flows
Monday Morning Buys pound futures contract that matures in two days at ...

Solution Summary

Forward and Futures Contracts are embedded.

$2.19