Problem 8.

1 Peregrine Funds -- Jakarta

Samuel Samosir trades currencies for Peregrine Funds in Jakarta. He 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, he has
concluded that the Singapore dollar will appreciate versus the U.S. dollar in the coming 90 days, probably to about
$0.7000/S$. He has the following optons on the Singapore dollar to choose from:

Option choices on the Singapore dollar: Call on S$ Put on S$

Strike price (US$/Singapore dollar) $0.6500 $0.6500
Premium (US$/Singapore dollar) $0.00046 $0.00003

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

a) Should Samuel buy a put on Singapore dollars or a call on Singapore dollars?

Since Samuel expects the Singapore dollar to appreciate versus the US dollar, he should buy a call on Singapore dollars.
This gives him the right to BUY Singapore dollars at a future date at $0.65 each, and then immediately resell them in the
open market at $0.70 each for a profit. (If his expectation of the future spot rate proves correct.)

b Using your answer to part (a), what is Samuel's breakeven price?

Per S$
Strike price $0.65000
Note this does not include any interest cost on the premium. Plus premium $0.00046
Breakeven $0.65046

c) Using your answer to part (a), what is Samuel's gross profit and net profit (including premium) if the spot rate at
the end of 90 days is indeed $0.70/S$?
Gross profit Net profit
(US$/S$) (US$/S$)
Spot rate $0.70000 $0.70000
Less strike price ($0.65000) ($0.65000)
Less premium ($0.00046)
Profit $0.05000 $0.04954

d) Using your answer to part (a), what is Samuel's gross profit and net profit (including premium) if the spot rate at
the end of 90 days is $0.80/S$?
Gross profit Net profit
(US$/S$) (US$/S$)
Spot rate $0.80000 $0.80000
Less strike price ($0.65000) ($0.65000)
Less premium ($0.00046)
Profit $0.15000 $0.14954
Problem 8.2 Paulo's Puts

Paulo writes a put option on Japanese yen with a strike price of $0.008000/¥ (¥125.00/$) at a premium of 0.0080 cents per yen and with an expiration date six month from
now. The option is for ¥12,500,000. What is Paulo's profit or loss at maturity if the ending spot rates are ¥110/$, ¥115/$, ¥120/$, ¥125/$, ¥130/$, ¥135/$, and ¥140/$?

a) b) c) d) e) f) g)
Assumptions Values Values Values Values Values Values Values
Notional principal (¥) 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$/¥) $0.008000 $0.008000 $0.008000 $0.008000 $0.008000 $0.008000 $0.008000
Premium (US$/¥) $0.000080 $0.000080 $0.000080 $0.000080 $0.000080 $0.000080 $0.000080

Ending spot rate (¥/US$) 110.00 115.00 120.00 125.00 130.00 135.00 140.00
in US$/¥ $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) ($0.000080)
Net profit (US$/¥) ($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 8.3 Amber McClain

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 8.1.

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 Exh8.1 ($/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 8.4 Black River Investments

Jennifer Magnussen, a currency trader for Chicago-based Black River Investments, 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 Jennifer buys 5 June pound futures, and the spot rate at maturity is $1.3980/pound, what is the value of her position?
b) If Jennifer sells 12 March pound futures, and the spot rate at maturity is $1.4560/pound, what is the value of her position?
c) If Jennifer buys 3 March pound futures, and the spot rate at maturity is $1.4560/pound, what is the value of her position?
d) If Jennifer sells 12 June pound futures, and the spot rate at maturity is $1.3980/pound, what is the value of her position?

a) b) c) d)
Assumptions Values Values Values Values
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: Jennifer buys at the futures price and sells at the ending spot price. She therefore profits when the futures price
is less than the ending spot price.
Sells a future: Jennifer buys at the ending spot price and sells at the futures price. She therefore profits when the futures price
is greater than the ending spot price.
Problem 8.5 Madera Capital

Katya Berezovsky works is a currency speculator for madera Capital of Los Angeles. 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) Using your answer to part (a), what is Katya's break even price?
Katya buys a put on yen. Pays premium today.
In 90 days, exercises the put, receiving US$.
in ¥/$
Strike price $0.00800 125.00
Less premium -$0.00003
Breakeven $0.00797 125.47

c) Using your answer to part (a), what is Katya's gross profit and net profit if the end spot rate is ¥140/$?

Gross profit Net profit

(US$/¥) (US$/¥)
Strike price $0.00800 $0.00800
Less spot rate -$0.00714 -$0.00714
Less premium -$0.00003
Profit $0.00086 $0.00083
Problem 8.6 Gnome Capital (A)

Stefan Weir trades currency for Gnome Capital of Geneva. Stefan 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 $1.3558/€, while the 30-day forward rate is $1.3550/€.

a. If Stefan believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be
$1.3600/€ at the end of 30 days, what should he do?

b. If Stefan believes the euro will depreciate in value against the U.S. dollar, so that he expects the spot rate to be $1.2800/€ at
the end of 30 days, what should he do?

a) b)
Assumptions Values Values
Initial investment (funds available) $10,000,000 $10,000,000
Current spot rate (US$/€) $1.3558 $1.3558
30-day forward rate (US$/€) $1.3550 $1.3550
Expected spot rate in 30 days (US$/€) $1.3600 $1.2800

Strategy for Part a):

One of the more interesting dimensions of speculating in the forward market, is that if the speculator has access to the forward
market (bank lines or relationships when working on behalf of an established firm), many forward speculation strategies require
no actual cash flow position up-front. In this case, Stefan believes the dollar will be trading at $1.36/€ in the open market at the
end of 30 days, but he has the ability to buy or sell dollars at a forward rate of $1.3550/€. He should therefore buy euros forward
30 days (requires no actual cash flow up-front), and at the end of 30 days take delivery of those euros and sell in the spot market
at the higher dollar rate for profit.

Initial investment principle $10,000,000.00

30 day forward rate (US$/€) $1.3550
Euros bought forward (Investment / forward rate) € 7,380,073.80
Spot rate in open market at end of 30 days (US$/€) $1.3600
US$ proceeds (euros bought forward exchanged to US$ spot) $10,036,900.37
Profit in US$ $36,900.37

Strategy for Part b):

Again, a profitable strategy can be executed without any actual cash flow changing hands at the beginning of the period. Since
Stefan believes that the dollar will strengthen to $1.28 in 30 days, he should sell euros forward now at the higher dollar rate,
wait 30 days and buy the euros needed on the open market at $1.28, and immediately then use those euros to fulfill his forward
contract to sell euros for dollars at $1.3350. For a profit.

Investment funds needed in 30 days $10,000,000.00

Spot rate in open market at end of 30 days $1.2800
Euros bought in open market in 30 days (Investment / spot rate) € 7,812,500.00

Stefan had sold these euros forward at the start of the 30 day period.
30 day forward rate (US$/€) $1.3550
US$ proceeds (euros sold forward into US$) $10,585,937.50
Profit in US$ $585,937.50
Problem 8.7 Gnome Capital (B)

Stefan Weir of Gnome Capital now 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 Stefan's expected profit assuming a pure spot market speculation strategy.
b. Calculate Stefan's 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 $0.5820
Three-month forward rate (US$/Swiss franc) $0.5640 $0.5640
Expected spot rate in three months (US$/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 three 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 three months (no cash outlay required)
2. Fulfill the three months forward in three 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 8.8 Call Profits

Assume a call option on euros is written with a strike price of $1.2500/€ at a premium of 3.80 cents 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:

Note: The option premium is 3.8 cents per euro, not 38 cents per euro.

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 8.9 Giri the Contrarian

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) Should Giri buy a put on the Canadian dollar or a call on the Canadian dollar?

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

b) Using your answer to part (a), what is Giri's break even price?

Strike price $0.7000

Plus premium 0.0249
Breakeven $0.7249

c) Using your answer to part (a), 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) Using your answer to part (a), 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 8.10 Downing Street

Sydney Reeks is a currency trader for Downing Street, a private investment house in London. Downing Street’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 located in London, all accounts and expectations are based in U.S. dollars.

Sydney 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$/£) $1.4260
Expected endings spot rate in 30 to 60 days (US$/£) $1.3200
Potential investment principal per person (£) £250,000.00

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

Strike price (US$/£) $1.36 $1.34 $1.32
Maturity (days) 30 30 30
Premium (US$/£) $0.00081 $0.00021 $0.00004

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

Strike price (US$/£) $1.36 $1.34 $1.32
Maturity (days) 60 60 60
Premium (US$/£) $0.00333 $0.00150 $0.00060

Issues for Sydney 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 Sydney 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 Sydney invested an individual's principal purely

in this specific option, they would purchase an
option of the following notional principal (£): £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 8.11 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 12.000% s 12.000%

Call option premium (per unit fc) c $0.0534 c € 0.0412

Put option premium (per unit fc) p $0.0643 p € 0.0342
(European pricing)

Call option premium (%) c 4.28% c 5.15%

Put option premium (%) p 5.15% p 4.27%

When the volatility is increased to 12.000% from 10.500%, the premium on the call option on euros rises to $0.0412/€, or 5.15%.
Problem 8.12 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%

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 8.13 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%

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 8.14 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%

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 8.15 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%

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