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FINC6013 Workshop 5 Questions

Chapter 20 Questions

1. How does a futures contract differ from a forward contract?

2. What effects does “marking to market” have on futures contracts?

3. What are the differences between foreign currency option contracts and forward contracts for foreign currency?

4. What are you buying if you purchase a U.S. dollar European put option against the Mexican peso with a strike price of MXN10.0/$ and a maturity of July? (Assume that it is May and the spot rate is MXN10.5/$.)

5. What are you buying if you purchase a Swiss franc American call option against the U.S. dollar with a strike price of CHF1.30/$ and a maturity of January? (Assume that it is November and the spot rate is CHF1.35/$.)

11. Your CEO routinely approves changes in the fire insurance policies of your firm to protect the value of its buildings and manufacturing equipment. Nevertheless, he argues that the firm should not buy foreign currency options because, he says, “We don’t speculate in FX markets!” How could you convince him that his positions are mutually inconsistent?

12. Why do options provide insurance against foreign exchange risks in bidding situations? Why can’t you hedge with a forward contract in a bidding situation?

13. Suppose that you have a foreign currency receivable (payable). What option strategy places a floor (ceiling) on your domestic currency revenue (cost)?

Chapter 20 problems

1. If you sold a Swiss franc futures contract at time t and the exchange rate has evolved as shown here, what would your cash flows have been? Initial margin is $2,000, and maintenance margin is $1,400. The contract size is CHF 125,000.

2. Given the following information, how much would you have paid on September 16 to purchase a British pound call option contract with a strike price of 155 and a maturity of October?

Data for September 16

Calls Puts

3. Using the data in problem 2, how much would you have paid to purchase a Australian dollar put option contract with a strike price of 65 and an October maturity?

4. Suppose that you buy a €1,000,000 call option against dollars with a strike price of $1.2750/€. Describe this option as the right to sell a specific amount of dollars for euros at a particular exchange rate of euros per dollar. Explain why this latter option is a dollar put option against the euro.

5. Assume that today is March 7, and, as the newest hire for Goldman Sachs, you must advise a client on the costs and benefits of hedging a transaction with options. Your client (a small U.S. exporting firm) is scheduled to receive a payment of €6,250,000 on April 20, 44 days in the future. Assume that your client can borrow and lend at a 6% p.a. U.S. interest rate.

a. Describe the nature of your client’s transaction exchange risk.

b. Use the appropriate American option with an April maturity and a strike price of 129¢/€ to determine the dollar cost today of hedging the transaction with an option strategy. The cost of the call option is 3.93¢/€, and the cost of the put option is 1.58¢/€.

c. What is the minimum dollar revenue your client will receive in April? Remember to take account of the opportunity cost of doing the option hedge.

d. Determine the value of the spot rate ($/€) in April that would make your client indifferent ex post to having done the option transaction or a forward hedge. The forward rate for delivery on April 20 is $1.30/€.