Problem 7.

1 Peso futures

Amber McClain, the currency speculator we met earlier in the chapter,sells eight June futures contracts for
500,000 pesos at the closing price quoted in Exhibit 7.1

a. What is the value of her position at maturity if the ending spotrate is $0.12000/Ps?
b. What is the value of her position at maturity if the ending spotrate is $0.09800/Ps?
c. What is the value of her position at maturity if the ending spotrate is $0.11000/Ps?

a) b) c)
Assumptions Values Values Values
Number of pesos per futures contract 500,000 500,000 500,000
Number of contracts 8.00 8.00 8.00
Buy or sell the peso futures? Sell Sell Sell

Ending spot rate ($/peso) $0.12000 $0.09800 $0.11000

June futures settle price from Exh7.1 ($/peso) $0.10773 $0.10773 $0.10773
Spot - Futures $0.01227 ($0.00973) $0.00227

Value of total position at maturity (US$) ($49,080.00) $38,920.00 ($9,080.00)

Value = - Notional x (Spot - Futures) x 8

Interpretation
Amber buys at the spot price and sells at the futures price.
If the futures price is greater than the ending spot price, she makes a profit.
Problem 7.2 Pound futures

Michael Palin, a currency trader for a New York investment firm, uses the following futures quotes on the British pound to speculate on the value of the British pound.

British Pound Futures, US$/pound (CME) Contract = 62,500 pounds

Open
Maturity Open High Low Settle Change High Interest
March 1.4246 1.4268 1.4214 1.4228 0.0032 1.4700 25,605
June 1.4164 1.4188 1.4146 1.4162 0.0030 1.4550 809

a. If Michael Palin buys 5 June pound futures, and the spot rate at maturity is $1.3980/pound, what is the value of his position?
b. If Michael Palin sells 12 March pound futures, and the spot rate at maturity is $1.4560/pound, what is the value of his position?
c. If Michael Palin buys 3 March pound futures, and the spot rate at maturity is $1.4560/pound, what is the value of his position?
d. If Michael Palin sells 12 June pound futures, and the spot rate at maturity is $1.3980/pound, what is the value of his position?

a) b) c) d)
Assumptions Values Values Values Values
Number of pounds (₤) per futures contract £62,500 £62,500 £62,500 £62,500
Maturity month June March March June
Number of contracts 5 12 3 12
Did he buy or sell the futures? buys sells buys sells

Ending spot rate ($/₤) $1.3980 $1.4560 $1.4560 $1.3980

Pound futures contract, settle price ($/₤) $1.4162 $1.4228 $1.4228 $1.4162
Spot - Futures ($0.0182) $0.0332 $0.0332 ($0.0182)

Value of position at maturity ($) ($5,687.50) ($24,900.00) $6,225.00 $13,650.00

buys: Notional x (Spot - Futures) x contracts
sells: - Notional x (Spot - Futures) x contracts

Interpretation
Buys a futures: Michael buys at the futures price and sells at the ending spot price. He therefore profits when the futures price is less than the ending spot price.
Sells a future: Michael buys at the ending spot price and sells at the futures price. He therefore profits when the futures price is greater than the ending spot price.
Problem 7.3 Hans Schmidt, euro speculator

Hans, is once again speculating on the movement of currencies. Hans has $10 million to begin with, and he must
state all profits at the end of any speculation in U.S. dollars. The spot rate on the euro is $0.8850/€, while the 30-
day forward rate is $0.9000/€

a. If Hans believes the euro will continue to slide in value against the U.S. dollar, so that he expects the spot rate
to be $0.8440/€ at the end of 30 days, what should he do?

b. If Hans believes the euro will appreciate in value against the U.S. dollar, so that he expects the spot rate to be
$0.9440/€ at the end of 30 days, what should he do?

a) b)
Assumptions Values Values
Initial investment (funds available) $10,000,000 $10,000,000
Current spot rate (US$/euro) $1.3358 $1.3358
30-day forward rate (US$/euro) $1.3350 $1.3350
Expected spot rate in 30 days (US$/euro) $1.3600 $1.2800

Strategy for Part a):

1. Sell euros 30-days forward (in euros) € 7,490,636.70
2. At the end of 30 days, buy these euros spot ($9,588,014.98)
3. At the end of 30 days, sell euros at forward rate $10,000,000.00
4. Realize profit $411,985.02

Strategy for Part b):

1. Convert US$ to euros at the current spot rate (US$) ($10,000,000.00)
(in euros) € 7,486,150.62
2. At the end of 30 days, convert back to US$ at spot rate $10,181,164.85
3. Realize profit $181,164.85
Problem 7.4 Hans Schmidt, Swiss franc speculator

Similar to the situation Hans saw in the chapter, Hans believes the Swiss franc will appreciate versus the U.S.
dollar in the coming three-month period. He has $100,000 to invest. The current spot rate is $0.5820/SF, the three-
month forward rate is $0.5640/SF, and he expects the spot rates to reach $0.6250/SF in three months.

a. Calculate Hans’ expected profit assuming a pure spot market speculation strategy.
b. Calculate Hans’ expected profit assuming he buys or sells SF three months forward.

a) b)
Assumptions Values Values
Initial investment (funds available) $100,000 $100,000
Current spot rate (US$/Swiss franc) $0.5820 $0.5820
Six-month forward rate (US$/Swiss franc) $0.5640 $0.5640
Expected spot rate in six months (US$/Swiss franc) $0.6250 $0.6250

Strategy for Part a):

1. Use the $100,000 today to buy SF at spot rate SFr. 171,821.31
2. Hold the SF indefinitely.
3. At the end of six months, convert SF at expected rate $0.6250
4. Yielding expected dollar revenues of $107,388.32
5. Realize profit (revenues less $100,000 initial invest) $7,388.32

Strategy for Part b):

1. Buy SF forward six months (no cash outlay required)
2. Fulfill the six months forward in six months SFr. 177,304.96
cost in US$ ($100,000.00)
3. Convert the SF into US$ at expected spot rate $110,815.60
4. Realize profit $10,815.60
Problem 7.5 Katya and the yen

Katya Berezovsky works in the currency trading unit of Sumara Workers Bank in Togliatti, Russia. Her latest
speculative position is to profit from her expectation that the U.S. dollar will rise significantly against the
Japanese yen. The current spot rate is ¥120.00/$. She must choose between the following 90-day options on
the Japanese yen:

Assumptions Values
Current spot rate (Japanese yen/US$) 120.00
in US$/yen $0.00833
Maturity of option (days) 90
Expected ending spot rate in 90 days (yen/$) 140.00
in US$/yen $0.00714

Call on yen Put on yen

Strike price (yen/US$) 125.00 125.00
in US$/yen $0.00800 $0.00800
Premium (US$/yen) $0.00046 $0.00003

a) Should she buy a call on yen or a put on yen?

Katya should buy a put on yen to profit from the rise of the dollar (the fall of the yen).

b) What is Katy'as break even price on her option of choice in part a)?
Katya buys a put on yen. Pays premium today.
In 90 days, exercises the put, receiving US$.
in yen/$
Strike price $0.00800 125.00
Less premium -$0.00003
Breakeven $0.00797 125.47

c) What is Katya's gross profit and net profit if the end spot rate is 140 yen/$?

Gross profit Net profit

(US$/yen) (US$/yen)
Strike price $0.00800 $0.00800
Less spot rate -$0.00714 -$0.00714
Less premium -$0.00003
Profit $0.00086 $0.00083
Problem 7.6 Samuel's bet

Samuel Samosir of Peregrine Investments in Jakarta, Indonesia, focuses nearly all of his time and attention on the U.S.
dollar/Singapore dollar ($/S$) cross-rate. The current spot rate is $0.6000/S$. After considerable study this week, he has
concluded that the Singapore dollar will appreciate versus the U.S. dollar in the coming 90 days, probably to about
$0.7000/S$.

Assumptions Values
Current spot rate (US$/Singapore dollar) $0.6000
Days to maturity 90
Expected spot rate in 90 days (US$/Singapore dollar) $0.7000

He has the following options on the Singapore dollar to choose from:

Option choices on the Singapore dollar: Call option Put option

Strike price (US$/Singapore dollar) $0.6500 $0.6500
Premium (US$/Singapore dollar) $0.0002 $0.0449

a) Which option should Samuel buy?

Since Samuel expects the Singapore dollar to appreciate versus the US dollar, he should buy a call on Singapore dollars.

b) What is Samuel's breakeven price on the option purchased in part a)?

Strike price $0.6500

Plus premium $0.0002
Breakeven $0.6502

c) What is Samuel's gross profit and net profit (including premium) if the ending spot rate is $0.70/S$?

Gross profit Net profit

(US$/S$) (US$/S$)
Spot rate $0.7000 $0.7000
Less strike price ($0.6500) ($0.6500)
Less premium ($0.0002)
Profit $0.0500 $0.0498

d) What is Samuel's gross profit and net profit (including premium) if the ending spot rate is $0.80/S$?

Gross profit Net profit

(US$/S$) (US$/S$)
Spot rate $0.8000 $0.8000
Less strike price ($0.6500) ($0.6500)
Less premium ($0.0002)
Profit $0.1500 $0.1498
Problem 7.7 How much profit -- calls?

Assume a call option on euros is written with a strike price of $1.2500/€ at a premium of 3.80¢ per euro ($0.0380/€) and with an expiration date three months from now. The
option is for €100,000. Calculate your profit or loss should you exercise before maturity at a time when the euro is traded spot at .....

a) b) c) d) e) f) g)
Assumptions Values Values Values Values Values Values Values
Notional principal (euros) € 100,000.00 € 100,000.00 € 100,000.00 € 100,000.00 € 100,000.00 € 100,000.00 € 100,000.00
Maturity (days) 90 90 90 90 90 90 90
Strike price (US$/euro) $1.2500 $1.2500 $1.2500 $1.2500 $1.2500 $1.2500 $1.2500
Premium (US$/euro) $0.0380 $0.0380 $0.0380 $0.0380 $0.0380 $0.0380 $0.0380
Ending spot rate (US$/euro) $1.1000 $1.1500 $1.2000 $1.2500 $1.3000 $1.3500 $1.4000

Gross profit on option $0.0000 $0.0000 $0.0000 $0.0000 $0.0500 $0.1000 $0.1500
Less premium ($0.0380) ($0.0380) ($0.0380) ($0.0380) ($0.0380) ($0.0380) ($0.0380)
Net profit (US$/euro) ($0.0380) ($0.0380) ($0.0380) ($0.0380) $0.0120 $0.0620 $0.1120

Net profit, total ($3,800.00) ($3,800.00) ($3,800.00) ($3,800.00) $1,200.00 $6,200.00 $11,200.00
Problem 7.8 How much profit -- puts?

Assume a put option on Japanese yen is written with a strike price of $0.008000/¥ (¥125.00/$) at a premium of 0.0080¢ per yen and with an expiration date six month from
now. The option is for ¥12,500,000. Calculate your profit or loss should you exercise before maturity at a time when the yen is traded spot at :

a) b) c) d) e) f) g)
Assumptions Values Values Values Values Values Values Values
Notional principal (yen) 12,500,000 12,500,000 12,500,000 12,500,000 12,500,000 12,500,000 12,500,000
Maturity (days) 180 180 180 180 180 180 180
Strike price (US$/yen) $0.008000 $0.008000 $0.008000 $0.008000 $0.008000 $0.008000 $0.008000
Premium (US$/yen) $0.000080 $0.000080 $0.000080 $0.000080 $0.000080 $0.000080 $0.000080

Ending spot rate (yen/US$) 110.00 115.00 120.00 125.00 130.00 135.00 140.00
in US$/yen $0.009091 $0.008696 $0.008333 $0.008000 $0.007692 $0.007407 $0.007143

Gross profit on option $0.000000 $0.000000 $0.000000 $0.000000 $0.000308 $0.000593 $0.000857
Less premium ($0.000080) ($0.000080) ($0.000080) ($0.000080) ($0.000080) ($0.000080) ($0.000080)
Net profit (US$/yen) ($0.000080) ($0.000080) ($0.000080) ($0.000080) $0.000228 $0.000513 $0.000777

Net profit, total ($1,000.00) ($1,000.00) ($1,000.00) ($1,000.00) $2,846.15 $6,407.41 $9,714.29
Problem 7.9 Falling Canadian dollar

Giri Patel works for CIBC Currency Funds in Toronto. Giri is something of a contrarian -- as opposed to most of the
forecasts, he believes the Canadian dollar (C$) will appreciate versus the U.S. dollar over the coming 90 days. The
current spot rate is $0.6750/C$. Giri may choose between the following options on the Canadian dollar:

Assumptions Values
Current spot rate (US$/Canadian dollar) $0.6750
Days to maturity 90

Option choices on the Canadian dollar: Call option Put option

Strike price (US$/Canadian dollar) $0.7000 $0.7000
Premium (US$/Canadian dollar) $0.0249 $0.0003

a) Which option should Giri buy?

Since Giri expects the Canadian dollar to appreciate versus the US dollar, he should buy a call on Canadian dollars.

b) What is Giri's breakeven price on the option purchased in part a)?

Strike price $0.7000

Plus premium 0.0249
Breakeven $0.7249

c) What is Giri's gross profit and net profit (including premium) if he ending spot rate is $0.7600/C$?

Gross profit Net profit

(US$/C$) (US$/C$)
Spot rate $0.7600 $0.7600
Less strike price (0.7000) (0.7000)
Less premium (0.0249)
Profit $0.0600 $0.0351

d) What is Giri's gross profit and net profit (including premium) if the ending spot rate is $0.8250/C$?

Gross profit Net profit

(US$/C$) (US$/C$)
Spot rate $0.8250 $0.8250
Less strike price (0.7000) (0.7000)
Less premium (0.0249)
Profit $0.1250 $0.1001
Problem 7.10 Braveheart puts on pounds

Andy Furstow is a speculator for a currency fund in London named Braveheart. Braveheart’s clients are a collection of wealthy private
investors who, with a minimum stake of £250,000 each, wish to speculate on the movement of currencies. The investors expect annual
returns in excess of 25%. Although officed in London, all accounts and expectations are based in U.S. dollars.
Andy Furstow is convinced that the British pound will slide significantly -- possibly to $1.3200/£ -- in the coming 30 to 60 days.
The current spot rate is $1.4260/£. Andy wishes to buy a put on pounds which will yield the 25% return expected by his investors.
Which of the following put options would you recommend he purchase. Prove your choice is the preferable combination of strike price,
maturity, and up-front premium expense.

Assumptions Values
Current spot rate (US$/pound) $1.4260
Expected endings spot rate in 30 to 60 days (US$/pnd) $1.3200
Potential investment principal per person (pounds) £250,000.00

Put options on pounds Put #1 Put #2 Put #3

Strike price (US$/pound) $1.36 $1.34 $1.32
Maturity (days) 30 30 30
Premium (US$/pound) $0.00 $0.00 $0.00

Put options on pounds Put #4 Put #5 Put #6

Strike price (US$/pound) $1.36 $1.34 $1.32
Maturity (days) 60 60 60
Premium (US$/pound) $0.00 $0.00 $0.00

Issues for Andy Furstow to consider:

1. Because his expectation is for "30 to 60 days" he should confine his choices to the 60 day options to be sure and capture
the timing of the exchange rate change. (We have no explicit idea of why he believes this specific timing.)

2. The choice of which strike price is an interesting debate.

* The lower the strike price (1.34 or 1.32), the cheaper the option price.
* The reason they are cheaper is that, statistically speaking, they are increasingly less likely to end up in the money.
* The choice, given that all the options are relatively "cheap," is to pick the strike price which will yield the required return.
* The $1.32 strike price is too far 'down,' given that Andy Furstow only expects the pound to fall to about $1.32.

Put #4 Put #5 Put #6

Net profit Net profit Net profit
Strike price $1.36000 $1.34000 $1.32000
Less expected spot rate (1.32000) (1.32000) (1.32000)
Less premium (0.00333) (0.00150) (0.00060)
Profit $0.03667 $0.01850 ($0.00060)

If Andy invested an individual's principal purely

in this specific option, they would purchase an
option of the following notional principal (pounds): £75,075,075.08 £166,666,666.67 £416,666,666.67

Expected profit, in total (profit rate x notional): $2,753,003.00 $3,083,333.33 -$250,000.00

Initial investment at current spot rate $356,500.00 $356,500.00 $356,500.00
Return on Investment (ROI) 772% 865% -70%
Risk: They could lose it all (full premium)
Problem 7.11 U.S. dollar/euro

Pricing Currency Options on the Euro

A U.S.-based firm wishing to buy A European firm wishing to buy

or sell euros (the foreign currency) or sell dollars (the foreign currency)

Variable Value Variable Value

Spot rate (domestic/foreign) S0 $1.2480 S0 € 0.8013
Strike rate (domestic/foreign) X $1.2500 X € 0.8000
Domestic interest rate (% p.a.) rd 1.453% rd 2.187%
Foreign interest rate (% p.a.) rf 2.187% rf 1.453%
Time (years, 365 days) T 1.000 T 1.000
Days equivalent 365.00 365.00
Volatility (% p.a.) s 10.500% s 10.500%

Call option premium (per unit fc) c $0.0461 c € 0.0366

Put option premium (per unit fc) p $0.0570 p € 0.0295
(European pricing)

Call option premium (%) c 3.69% c 4.56%

Put option premium (%) p 4.57% p 3.68%

Copyright © 2004, Barbara S. Petitt and Michael H. Moffett, Thunderbird, The American Graduate School of International Management.
Problem 7.12 U.S. dollar/Japanese yen

Pricing Currency Options on the Japanese yen

A Japanese firm wishing to buy A U.S.-based firm wishing to buy

or sell dollars (the foreign currency) or sell yen (the foreign currency)

Variable Value Variable Value

Spot rate (domestic/foreign) S0 JPY 105.64 S0 $0.0095
Strike rate (domestic/foreign) X JPY 100.00 X $0.0100
Domestic interest rate (% p.a.) rd 0.089% rd 1.453%
Foreign interest rate (% p.a.) rf 1.453% rf 0.089%
Time (years, 365 days) T 1.000 T 1.000
Days equivalent 365.00 365.00
Volatility (% p.a.) s 12.000% s 12.000%

Call option premium (per unit fc) c JPY 7.27 c $0.0003

Put option premium (per unit fc) p JPY 3.06 p $0.0007
(European pricing)

Call option premium (%) c 6.88% c 3.06%

Put option premium (%) p 2.90% p 7.27%

Copyright © 2004, Barbara S. Petitt and Michael H. Moffett, Thunderbird, The Garvin School of International Management.

A Japanese firm wishing to sell U.S. dollars would need to purchase a put on dollars. The put option premium listed above is JPY3.06/$.

Put option premium (JPY/US$) JPY 3.06

Notional principal (US$) $750,000
Total cost (JPY) JPY 2,297,243
Problem 7.13 Euro/Japanese yen

Pricing Currency Options on the Euro/Yen Crossrate

A Japanese firm wishing to buy A European firm wishing to buy

or sell euros (the foreign currency) or sell yen (the foreign currency)

Variable Value Variable Value

Spot rate (domestic/foreign) S0 JPY 133.89 S0 € 0.0072
Strike rate (domestic/foreign) X JPY 136.00 X € 0.0074
Domestic interest rate (% p.a.) rd 0.088% rd 2.187%
Foreign interest rate (% p.a.) rf 2.187% rf 0.088%
Time (years, 365 days) T 0.247 T 0.247
Days equivalent 90.00 90.00
Volatility (% p.a.) s 10.000% s 10.000%

Call option premium (per unit fc) c JPY 1.50 c € 0.0001

Put option premium (per unit fc) p JPY 4.30 p € 0.0002
(European pricing)

Call option premium (%) c 1.12% c 1.30%

Put option premium (%) p 3.21% p 2.90%

Copyright © 2004, Barbara S. Petitt and Michael H. Moffett, Thunderbird, The Garvin School of International Management.

A European-based firm like Legrand (France) would need to purchase a put option on the Japanese yen. The company wishes a strike rate of
0.0072 euro for each yen sold (the strike rate) and a 90-day maturity. Note that the "Time" must be entered as the fraction of a 365 day year, in
this case, 90/365 = 0.247.

Put option premium (euro/JPY) € 0.0002

Notional principal (JPY) JPY 10,400,000
Total cost (euro) € 2,167.90
Problem 7.14 U.S. dollar/British pound

Pricing Currency Options on the British pound

A U.S.-based firm wishing to buy A British firm wishing to buy

or sell pounds (the foreign currency) or sell dollars (the foreign currency)

Variable Value Variable Value

Spot rate (domestic/foreign) S0 $1.8674 S0 £0.5355
Strike rate (domestic/foreign) X $1.8000 X £0.5556
Domestic interest rate (% p.a.) rd 1.453% rd 4.525%
Foreign interest rate (% p.a.) rf 4.525% rf 1.453%
Time (years, 365 days) T 0.493 T 0.493
Days equivalent 180.00 180.00
Volatility (% p.a.) s 9.400% s 9.400%

Call option premium (per unit fc) c $0.0696 c £0.0091

Put option premium (per unit fc) p $0.0306 p £0.0207
(European pricing)

Call option premium (%) c 3.73% c 1.70%

Put option premium (%) p 1.64% p 3.87%

Copyright © 2004, Barbara S. Petitt and Michael H. Moffett, Thunderbird, The Garvin School of International Management.

Call option premiums for a U.S.-based firm buying call options on the British pound:

180-day maturity ($/pound) $0.0696

90-day maturity ($/pound) $0.0669
Difference ($/pound) $0.0027

The maturity doubled while the option premium rose only about 4%.
Problem 7.15 Euro/British pound

Pricing Currency Options on the British pound/Euro Crossrate

A European firm wishing to buy A British firm wishing to buy

or sell pounds (the foreign currency) or sell euros (the foreign currency)

Variable Value Variable Value

Spot rate (domestic/foreign) S0 € 1.4730 S0 £0.6789
Strike rate (domestic/foreign) X € 1.5000 X £0.6667
Domestic interest rate (% p.a.) rd 4.000% rd 4.160%
Foreign interest rate (% p.a.) rf 4.160% rf 4.000%
Time (years, 365 days) T 0.247 T 0.247
Days equivalent 90.00 90.00
Volatility (% p.a.) s 11.400% s 11.400%

Call option premium (per unit fc) c € 0.0213 c £0.0220

Put option premium (per unit fc) p € 0.0487 p £0.0097
(European pricing)

Call option premium (%) c 1.45% c 3.24%

Put option premium (%) p 3.30% p 1.42%

Copyright © 2004, Barbara S. Petitt and Michael H. Moffett, Thunderbird, The Garvin School of International Management.

When the euro's interest rate rises from 2.072% to 4.000%, the call option premium on British pounds rises:

Call option on pounds when euro interest is 4.000% € 0.0213

Call option on pounds when euro interest is 2.072% € 0.0189
Change, an increase in the premium € 0.0213