| Assignment 3 | |
| Instructions | |
| Complete the following questions and submit your answers to the Dropbox by midnight Sunday:
| |
Chapter 7
Question 1
Explain the basic differences between the operation of a currency forward market and a
futures market.
Question 2
In order for a derivatives market to function most efficiently, two types of economic agents are
needed: hedgers and speculators. Explain.
Question 3
Why are most futures positions closed out through a reversing trade rather than held to
delivery?
Question 4
How can the FX futures market be used for price discovery?
Question 5
What is the major difference in the obligation of one with a long position in a futures (or
forward) contract in comparison to an options contract?
Question 6
What is meant by the terminology that an option is in-, at-, or out-of-the-money?
Question 7
List the arguments (variables) of which an FX call or put option model price is a function.
How does the call and put premium change with respect to a change in the arguments?
Problem 1
Assume today's settlement price on a CME EUR futures contract is $1.3140/EUR.
You have a short position in one contract. Your performance bond account currently
has a balance of $1,700. The next three days' settlement prices are $1.3126, $1.3133,
and $1.3049. Calculate the changes in the performance bond account from daily
marking-to-market and the balance of the performance bond account after the third day.
Problem 2
Do problem 1 again assuming you have a long position in the futures contract.
Problem 9
Assume spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950. What is the
minimum price that a six-month American call option with a striking price of $0.6800 should sell
for in a rational market? Assume the annualized six-month Eurodollar rate is 3 ½ percent.
Problem 10
Do problem 9 again assuming an American put option instead of a call option.
Chapter 8
Question 1
How would you define transaction exposure? How is it different from economic exposure?
Question 2
Discuss and compare hedging transaction exposure using the forward contract vs. money market instruments. When do the alternative hedging approaches produce the same result?
Question 3
Discuss and compare the costs of hedging via the forward contract and the options contract.
Question 4
What are the advantages of a currency options contract as a hedging tool compared with the forward contract?
Question 5
Suppose your company has purchased a put option on the German mark to manage exchange exposure associated with an account receivable denominated in that currency. In this case, your company can be said to have an 'insurance' policy on its receivable. Explain in what sense this is so.
Question 6
Recent surveys of corporate exchange risk management practices indicate that many U.S. firms simply do not hedge. How would you explain this result?
Question 7
Should a firm hedge? Why or why not?
Question 8
Using an example, discuss the possible effect of hedging on a firm's tax obligations.
Problem 3
You plan to visit Geneva, Switzerland in three months to attend an international business conference. You expect to incur the total cost of SF 5,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is $0.60/SF and the three-month forward rate is $0.63/SF. You can buy the three-month call option on SF with the exercise rate of $0.64/SF for the premium of $0.05 per SF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per annum in the United States and 4 percent per annum in Switzerland.
(a) Calculate your expected dollar cost of buying SF5,000 if you choose to hedge via call option on SF.
(b) Calculate the future dollar cost of meeting this SF obligation if you decide to hedge using a forward contract.
(c) At what future spot exchange rate will you be indifferent between the forward and option market hedges?
(d) Illustrate the future dollar costs of meeting the SF payable against the future spot exchange rate under both the options and forward market hedges.
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