CH 77

International Financial Management, 8e (Eun)
Chapter 7 Futures and Options on Foreign Exchange
1)
Answer: TRUE
Topic: Basic Option-Pricing Relationships at Expiration
Accessibility: Keyboard Navigation
A) is an example of a forward contract.

B) is an example of a futures contract.
C) is an example of a put option.
D) is an example of a call option.
Answer: B
Topic: Futures Contracts: Some Preliminaries
futures price closes today at $1.46. How much have you made/lost?
A) Depends on your margin balance.
B) You have made $2,500.00.
C) You have lost $2,500.00.
D) You have neither made nor lost money, yet.
Answer: C
Explanation: You will pay $93,750 under your futures contract (found by 62,500 × 1.5), but the
new price would have resulted in a payment of $91,250. $91,250 $93,750 = $2,500.
4) In reference to the futures market, a "speculator"

A) attempts to profit from a change in the futures price.
B) wants to avoid price variation by locking in a purchase price of the underlying asset through a
long position in the futures contract or a sales price through a short position in the futures
contract.
C) stands ready to buy or sell contracts in unlimited quantity.
D) wants to avoid price variation by locking in a purchase price of the underlying asset through a
long position in the futures contract or a sales price through a short position in the futures
contract, and also stands ready to buy or sell contracts in unlimited quantity.
Answer: A
5) Comparing "forward" and "futures" exchange contracts, we can say that
A) they are both "marked-to-market" daily.
B) their major difference is in the way the underlying asset is priced for future purchase or sale:
futures settle daily and forwards settle at maturity.
C) a futures contract is negotiated by open outcry between floor brokers or traders and is traded
on organized exchanges, while forward contract is tailor-made by an international bank for its
clients and is traded OTC.
D) their major difference is in the way the underlying asset is priced for future purchase or sale:
futures settle daily and forwards settle at maturity, and a futures contract is negotiated by open
outcry between floor brokers or traders and is traded on organized exchanges, while a forward
contract is tailor-made by an international bank for its clients and is traded OTC.
Answer: D
6) Comparing "forward" and "futures" exchange contracts, we can say that

A) delivery of the underlying asset is seldom made in futures contracts.
B) delivery of the underlying asset is usually made in forward contracts.
C) delivery of the underlying asset is seldom made in either contract they are typically cash
settled at maturity.
D) delivery of the underlying asset is seldom made in futures contracts and delivery of the
underlying asset is usually made in forward contracts.
Answer: D
7) In which market does a clearinghouse serve as a third party to all transactions?

A) Futures
B) Forwards
C) Swaps
D) none of the options
Answer: A
8) In the event of a default on one side of a futures trade,
A) the clearing member stands in for the defaulting party.
B) the clearing member will seek restitution for the defaulting party.
C) if the default is on the short side, a randomly selected long contract will not get paid. That
party will then have standing to initiate a civil suit against the defaulting short.
D) the clearing member stands in for the defaulting party and will seek restitution for the
defaulting party.
Answer: D
performance bond is $1,500 and your maintenance level is $500. At what settle price will you get
a demand for additional funds to be posted?
Answer: D
Explanation: $93,750
performance bond is $1,500 and your maintenance level is $500. At what settle price will you get
a demand for additional funds to be posted?
Answer: A
Explanation: $134,250
maintenance margin is $2,000 (meaning that your broker leaves you alone until your account
balance falls to $2,000). At what settle price (use 4 decimal places) do you get a margin call?
Answer: A
Explanation: $93,750 $1,750 =
past three days the contract has settled at $1.50, $1.52, and $1.54. How much have you made or
lost?
Answer: A
Explanation: You will sell your euros for $93,750. The highest contract price over the three
days was $1.54. Thus, you could have sold your euros for $96,250 (found by 62,500 × 1.54).
Finally, $96,250 $93,750 = $2,500.
13) Today's settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is
$0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days'
settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of
one CME yen contract is ¥12,500,000). If you have a short position in one futures contract, the
changes in the margin account from daily marking-to-market will result in the balance of the
margin account after the third day to be
A) $1,425.
B) $2,000.
C) $2,325.
D) $3,425.
Answer: C
Explanation: $2,000 + ¥12,500,000 [(0.008011 0.008057) + (0.008057 0.007996) +
(0.007996 0.007985)] = $2,325, where 0.008011 = $0.8011/¥100, 0.008057 = $0.8057//¥100,
0.007996 = $0.7996//¥100, and 0.007985 = $0.7985/¥100.
Topic: Currency Futures Markets
14) Today's settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is
$0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days'
settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of
one CME yen contract is ¥12,500,000). If you have a long position in one futures contract, the
changes in the margin account from daily marking-to-market, will result in the balance of the
margin account after the third day to be
A) $1,425.
B) $1,675.
C) $2,000.
D) $3,425
Answer: B
Explanation: $2,000 + ¥12,500,000 [(0.008057 0.008011) + (0.007996 0.008057) +
(0.007985 0.007996)] = $1,675, where 0.008057 = $0.8057//¥100, 0.008011 = $0.8011/¥100,
0.007996 = $0.7996//¥100, and 0.007985 = $0.7985/¥100.
15) Suppose the futures price is below the price predicted by IRP. What steps would assure an
arbitrage profit?
A) Go short in the spot market, go long in the futures contract.
B) Go long in the spot market, go short in the futures contract.
C) Go short in the spot market, go short in the futures contract.
D) Go long in the spot market, go long in the futures contract.
Answer: A
16) What paradigm is used to define the futures price?

A) IRP
B) Hedge Ratio
C) Black Scholes
D) Risk Neutral Valuation
Answer: A
17) Suppose you observe the following one-year interest rates, spot exchange rates and futures
prices. Futures contracts are avai -free arbitrage profit could you
make on one contract at maturity from this mispricing?
Exchange Rate Interest Rate APR

S0 i$4%
F360 i 3%
A) $159.22
B) $153.10
C) $439.42
Answer: A
in one year for $14,800).
$14,800, and then we repay our dollar borrowing with $14,640.78. Our risk-free profit = $159.22
= $14,800 $14,640.78.
18) Which equation is used to define the futures price?
A) =
B) =
C) =
D) F -S -
Answer: A
19) Which equation is used to define the futures price?
A) =
B) =
C) =
D) =
Answer: A
20) If a currency futures contract (direct quote) is priced below the price implied by Interest Rate
Parity (IRP), arbitrageurs could take advantage of the mispricing by simultaneously
A) going short in the futures contract, borrowing in the domestic currency, and going long in the
foreign currency in the spot market.
B) going short in the futures contract, lending in the domestic currency, and going long in the
C) going long in the futures contract, borrowing in the domestic currency, and going short in the
D) going long in the futures contract, borrowing in the foreign currency, and going long in the
domestic currency, investing the proceeds at the local rate of interest.
Answer: D
21) Open interest in currency futures contracts

A) tends to be greatest for the near-term contracts.
B) tends to be greatest for the longer-term contracts.
C) typically decreases with the term to maturity of most futures contracts.
D) tends to be greatest for the near-term contracts, and typically decreases with the term to
maturity of most futures contracts.
Answer: D
Topic: Basic Currency Futures Relationships
22) The "open interest" shown in currency futures quotations is
A) the total number of people indicating interest in buying the contracts in the near future.
B) the total number of people indicating interest in selling the contracts in the near future.
C) the total number of people indicating interest in buying or selling the contracts in the near
future.
D) the total number of long or short contracts outstanding for the particular delivery month.
Answer: D
Topic: Basic Currency Futures Relationships
23) If you think that the dollar is going to appreciate against the euro, you should
A) buy put options on the euro.
B) sell call options on the euro.
C) buy call options on the euro.
Answer: C
Topic: Options Contracts: Some Preliminaries
B)
Answer: A
due an option premium of $1,875. Thus, $96,875 $1,875 = $95,000. Solve the following for X:
($96,875 / $1.55) = ($95,000 / X).
25) A European option is different from an American option in that

A) one is traded in Europe and one in traded in the United States.
B) European options can only be exercised at maturity; American options can be exercised prior
to maturity.
C) European options tend to be worth more than American options, ceteris paribus.
D) American options have a fixed exercise price; European options' exercise price is set at the
average price of the underlying asset during the life of the option.
Answer: B
26) An "option" is
A) a contract giving the seller (writer) of the option the right, but not the obligation, to buy (call)
or sell (put) a given quantity of an asset at a specified price at some time in the future.
B) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (call)
or sell (put) a given quantity of an asset at a specified price at some time in the future.
C) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put)
or sell (call) a given quantity of an asset at a specified price at some time in the future.
D) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put)
or sell (sell) a given quantity of an asset at a specified price at some time in the future.
Answer: B
27) An investor believes that the price of a stock, say IBM's shares, will increase in the next 60
days. If the investor is correct, which combination of the following investment strategies will
show a profit in all the choices?
(i) buy the stock and hold it for 60 days

(ii) buy a put option
(iii) sell (write) a call option
(iv) buy a call option
(v) sell (write) a put option
A) (i), (ii), and (iii)

B) (i), (ii), and (iv)
C) (i), (iv), and (v)
D) (ii) and (iii)
Answer: C
28) Most exchange traded currency options

A) mature every month, with daily resettlement.
B) have original maturities of 1, 2, and 3 years.
C) have original maturities of 3, 6, 9, and 12 months.
D) mature every month, without daily resettlement.
Answer: C
Topic: Currency Options Markets
29) The volume of OTC currency options trading is
A) much smaller than that of organized-exchange currency option trading.
B) much larger than that of organized-exchange currency option trading.
C) larger, because the exchanges are only repackaging OTC options for their customers.
Answer: B
30) In the CURRENCY TRADING section of The Wall Street Journal, the following appeared
under the heading OPTIONS:
Philadelphia Exchange Puts

Swiss France 69.33
62,500 Swiss Francs-cents per unit Vol. Last
68 May 12 0.30
69 May 50 0.50
Which combination of the following statements are true?
(i) The time values of the 68 May and 69 May put options are respectively .30 cents and .50
cents.
(ii) The 68 May put option has a lower time value (price) than the 69 May put option.
(iii) If everything else is kept constant, the spot price and the put premium are inversely related.
(iv) The time values of the 68 May and 69 May put options are, respectively, 1.63 cents and 0.83
cents.
(v) If everything else is kept constant, the strike price and the put premium are inversely related.
A) (i), (ii), and (iii)
B) (ii), (iii), and (iv)
C) (iii) and (iv)
D) (iv) and (v)
Answer: A
31) With currency futures options the underlying asset is

A) foreign currency.
B) a call or put option written on foreign currency.
C) a futures contract on the foreign currency.
Answer: C
Topic: Currency Futures Options
32) Exercise of a currency futures option results in

A) a long futures position for the call buyer or put writer.
B) a short futures position for the call buyer or put writer.
C) a long futures position for the put buyer or call writer.
D) a short futures position for the call buyer or put buyer.
Answer: A
33) A currency futures option amounts to a derivative on a derivative. Why would something
like that exist?
A) For some assets, the futures contract can have lower transaction costs and greater liquidity
than the underlying asset.
B) Tax consequences matter as well, and for some users an option contract on a future is more
tax efficient.
C) Transaction costs and liquidity
D) all of the options
Answer: D
-month forward rate is $1.60 =

-month American call option on
at-the-money, the strike price must be
C) $1.55 × .
Answer: B
35) The current spot -month forward rate is $1.60 =

-
A) $6,125.
B) $6,125/(1 + )3/12.
C) negative profit, so exercise would not occur.
D) $3,125.
Answer: D
$1.50) = $3,125
-month forward rate is $1.60 =

-
break-even?
B) $1.62
Answer: A
also must pay a $5,000 option premium, so if exercised, the total amount paid will be $93,750 +
$5,000 = $98,750. Solve the following for X: ($96,875 / $1.55) = ($98,750 / X).
37) Consider this graph of a call option. The option is a three-month American call option on
values of A, B, and C, respectively?
A) A = $3,125 (or $.05 depending on your scale); B = $1.50; C = $1.55
C) A = $.05; B = $1.55; C = $1.60

Answer: A
find C, A and B (the exercise price) must be added together. Thus, C = $0.05 + $1.50 = $1.55.
A) A
B) B
C) C
D) D
Answer: B
-month U.S. dollar interest rate is 2

percent. Consider a three-
is the least that this option should sell for?
A) $0.05 × 62,500 = $3,125
B) $3,125/1.02 = $3,063.73
C) $0.00
Answer: A
Topic: American Option-Pricing Relationships
40) Which of the follow options strategies are consistent in their belief about the future behavior
of the underlying asset price?
A) Selling calls and selling puts
B) Buying calls and buying puts
C) Buying calls and selling puts
Answer: C
41) American call and put premiums

A) should be at least as large as their intrinsic value.
B) should be no larger than their intrinsic value.
C) should be exactly equal to their time value.
D) should be no larger than their speculative value.
Answer: A
42) Which of the following is correct?

A) Time value = intrinsic value + option premium
B) Intrinsic value = option premium + time value
C) Option premium = intrinsic value time value
D) Option premium = intrinsic value + time value
Answer: D

A) European options can be exercised early.
B) American options can be exercised early.
C) Asian options can be exercised early.
Answer: B
44) Assume that the dollar euro spot rate is $1.28 and the six-month forward rate is
= $1.28 = $1.2864. The six-month U.S. dollar rate is 5 percent and the
Eurodollar rate is 4 percent. The minimum price that a six-month American call option with a
striking price of $1.25 should sell for in a rational market is
A) 0 cents.
B) 3.47 cents.
C) 3.55 cents.
D) 3 cents.
Answer: C
Explanation: ($1.2864 $1.25) / (1 + 0.05)0.5 = 0.0355, which is greater than 0.03 = ($1.28
$1.25), so the minimum price in a rational market is 3.55 cents.
Topic: European Option-Pricing Relationships
45) For European options, what is the effect of an increase in St?

A) Decrease the value of calls and puts ceteris paribus
B)Increase the value of calls and puts ceteris paribus
C)Decrease the value of calls, increase the value of puts ceteris paribus
D)Increase the value of calls, decrease the value of puts ceteris paribus
Answer: D
46) For an American call option, A and B in the graph are
A) time value and intrinsic value.

B) intrinsic value and time value.
C) in-the-money and out-of-the money.
Answer: B
47) For European options, what is the effect of an increase in the strike price E?
Answer: C
48) For European currency options written on euro with a strike price in dollars, what is the
effect of an increase in r$ relative to r ?
Answer: D
effect of an increase in r$?
Answer: D
effect of an increase in r ?
Answer: C
A) Decreases the value of calls and puts ceteris paribus

B)Increases the value of calls and puts ceteris paribus
C)Decreases the value of calls, increases the value of puts ceteris paribus
D)Increases the value of calls, decreases the value of puts ceteris paribus
Answer: D
effect of an increase
A) Decreases the value of calls and puts ceteris paribus
B)Increases the value of calls and puts ceteris paribus
C)Decreases the value of calls, increases the value of puts ceteris paribus
D)Increases the value of calls, decreases the value of puts ceteris paribus
Answer: C
53) The hedge ratio
A) Is the size of the long (short) position the investor must have in the underlying asset per
option the investor must write (buy) to have a risk-free offsetting investment that will result in
the investor perfectly hedging the option.
B)
C) Is related to the number of options that an investor can write without unlimited loss while
holding a certain amount of the underlying asset.
Answer: D
Topic: Binomial Option-Pricing Model
period, there are two possibilities: the exchange rate will move up by 15 percent or down by 15
-free rate is 5 percent over the period.
2
The risk-neutral probability of dollar depreciation is /3 and the risk-neutral probability of the
dollar strengthening is 1/3.
A) $9.5238
B) $0.0952
C) $0
D) $3.1746
Answer: A
Explanation: Use C0 = [qCuT + (1 q)CdT] / (1 + r$) = (2/3)(15) + (1/3)(0) / (1 + .05) =
$9.5238
55) Use the binomial option pricing model to find the value of a call option on £10,000 with a
0/£1.00 and in the next period the
u = 1.6 and d = 1/u =
0.625). The current interest rates are i = 3% and are i£ = 4%. Choose the answer closest to
yours.
373
Answer: A
Explanation:
And thereby the value call is

=

u = 1.6 and d = 1/u = 0.625).
The current interest rates are i = 3% and are i£ = 4%.
Choose the answer closest to yours.
A) 5/9
B) 8/13
C) 2/3
D) 3/8
E) none of the options
Answer: B
Explanation:

57) You have written a call option on £10,000 with a strike price of $20,000. The current
exchange rate is $2.00/£1.00 and in the next period the exchange rate can increase to $4.00/£1.00
u = 2 and d = 1/u = 0. 5). The current interest rates are i$ = 3%
and are i£ = 2%. Find the hedge ratio and use it to create a position in the underlying asset that
will hedge your option position.
A) Enter into a short position in a futures contract on £6,666.67
B) Lend the present value of £6,666.67 today at i£ = 2%
C) Enter into a long position in a futures contract on £6,666.67
D) Lending the present value of £6,666.67 today at i£ = 2% or entering into a long position in a
futures contract on £6,666.67 would both work.
Answer: D
Explanation:

58) Draw the tree for a put option on $20,000 with a strike price of £10,000. The current
exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double
or be cut in half. The current interest rates are i$ = 3% and are i£ = 2%.
A)
B)
C) both of the options

Answer: B
59) Draw the tree for a call option on $20,000 with a strike price of £10,000. The current
exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double
or be cut in half. The current interest rates are i$ = 3% and are i£ = 2%.
A)
B)
C) both of the options

Answer: B
60) A binomial call option premium is calculated as
A) C0 = [qCuT+ (1 q)CdT] / (1 + r$)
B) C0 = [qCdT + (1 q)CuT] / (1 + r$)
C) C0 = [qCuT + (1 q)CdT] / (1 r$)
D) C0 = [qCdT + (1 q)CuT] / (1 r$)
Answer: A
61) The one-step binomial model assumes that at the end of the option period, the call will have
appreciated to SuT = S0u or depreciated to SdT = S0d. How is u calculated?
A) 1/d
B) 0.5)
C) both 1/d 0.5)
D) none of these options
Answer: C
62) Find the dollar value today of a 1-period at-the-
dollar value to $2.00
or fall to $1.00. The interest rate in dollars is i$ = 27.50%; the interest rate in euro is .
A) $3,308.82
B) $0
C) $3,294.12
D) $4,218.75
Answer: A
Explanation:
further that the hedge ratio is 1/2. Which of the following would be an appropriate hedge for a
short position in this call option?
day's spot exchange rate.
maturity of the option that prevails today (i.e
maturity of the option that prevails today (i.e
Answer: D
64) With regard to expiration date,

A) futures contracts do not have delivery dates.
B) forward contracts have standardized delivery dates.
C) futures contracts have tailor-made delivery dates that meet the needs of the investor.
D) futures contracts have standardized delivery dates.
Answer: D
Topic: Differences Between Futures and Forward Contracts
65) With regard to trading location,

A) forward contracts are traded competitively on organized exchanges.
B) futures contracts are traded competitively on organized exchanges.
C) futures contracts are traded by bank dealers via a network of telephones and computerized
dealing systems.
Answer: B
66) With regard to contractual size,

A) forward contracts are characterized by a standardized amount of the underlying asset.
B) futures contracts are tailor-made to the needs of the participant.
C) futures contracts are characterized by a standardized amount of the underlying asset.
Answer: C
67) With regard to trading costs,

A) forward contracts involve the bid-ask spread plus the broker's commission.
B) futures contracts involve the bid-ask spread plus the broker's commission.
C) futures contracts involve the bid-ask spread plus indirect bank charges via compensating
balance requirements.
Answer: B
A) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the
value (in dollars) of a put option on $10,000 with a strike price of £5,000 only when the spot
exchange rate is $2 = £1.
B) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the
value (in dollars) of a put option on $10,000 with a strike price of £5,000.
Answer: B
69) Find the input d1 of the Black-Scholes price of a six-

-
free rate is 5% over the period and the euro-zone risk-free rate is 4%. The volatility of the
underlying asset is 10.7 percent.
A) d1 = 0.103915
B) d1 = 2.9871
C) d1 = 0.0283
Answer: A
Explanation: First, you need to calculate Ft = $1.25e^[(0.05 0.04)(6/12)] = $1.256266. Next,
plug this into the formula for d1, where d1 = [ln(1.256266/1.25) + .5(0.1072)(6/12)] /
0.107(0.51/2) = 0.103915
Topic: European Option-Pricing Formula
70) Find the input d1 of the Black-Scholes price of a six-month call option on Japanese yen. The
strike price is $1 = ¥100. The volatility is 25 percent per annum; r$ = 5.5% and r¥ = 6%.
A) d1 = 0.074246
B) d1 = 0.005982
C) d1 = $0.006137/¥
Answer: A
Explanation: First, you need to calculate Ft = (1/100)e^[(0.055 0.06)(6/12)] = 1/100.2503.
Next, plug this into the formula for d1, where d1 = [ln((1/100.2503)/(1/100)) + .5(0.252)(6/12)] /
0.25(0.51/2) = 0.074246
71) The Black-Scholes option pricing formula
A) is used widely in practice, especially by international banks in trading OTC options.
B) is not widely used outside of the academic world.
C) works well enough, but is not used in the real world because no one has the time to flog their
calculator for five minutes on the trading floor.
Answer: A
72) Find the Black-Scholes price of a six-

-free rate is 5
percent over the period and the euro-zone risk-free rate is 4 percent. The volatility of the
underlying asset is 10.7 percent.
A) Ce = $0.63577
B) Ce = $0.0998
C) Ce = $1.6331
Answer: A
Explanation: First, you need to calculate Ft = $1.25e^[(0.05 0.04)(6/12)] = $1.256266. Next,
plug this into the formula for d1, where d1 = [ln(1.256266/1.25) + .5(0.1072)(6/12)] /
0.107(0.51/2) = 0.103915. Now, solve for d2, where d2 = d1 1/2) = 0.103915 - .107(0.52) =
0.028255. Plugging in, you should find C0 = 0.63577.
73) Use the European option pricing formula to find the value of a six-month call option on
Japanese yen. The strike price is $1 = ¥100. The volatility is 25 percent per annum; r$ = 5.5%
and r¥ = 6%.
A) 0.005395
B) 0.005982
C) $0.006137/¥
Answer: C
Explanation: First, you need to calculate Ft = (1/100)e^[(0.055 0.06)(6/12)] = 1/100.2503.
Next, plug this into the formula for d1, where d1 = [ln((1/100.2503)/(1/100)) + .5(0.252)(6/12)] /
0.25(0.51/2) = 0.074246. Now, solve for d2, where d2 = d1 1/2) = 0.074246 0.25(0.51/2)
= 0.10253. Plugging in, you should find C0 = $0.006137.
74) Empirical tests of the Black-Scholes option pricing formula

A) shows that binomial option pricing is used widely in practice, especially by international
banks in trading OTC options.
B) works well for pricing American currency options that are at-the-money or out-of-the-money.
C) does not do well in pricing in-the-money calls and puts.
D) works well for pricing American currency options that are at-the-money or out-of-the-money,
but does not do well in pricing in-the-money calls and puts.
Answer: D
Topic: Empirical Tests of Currency Options
75) Empirical tests of the Black-Scholes option pricing formula

A) have faced difficulties due to nonsynchronous data.
B) suggest that when using simultaneous price data and incorporating transaction costs they
conclude that the PHLX American currency options are efficiently priced.
C) suggest that the European option-pricing model works well for pricing American currency
options that are at- or out-of-the money, but does not do well in pricing in-the-money calls and
puts.
Answer: D
Topic: Empirical Tests of Currency Options
against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent.
On the other hand, the euro could depreciate against the pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Spot Rates Risk-free Rates

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Answer: = ×


S0 $1.60 = i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Find the risk neutral probability of an "up" move.
Answer: a = =
next period, if the pound appreciates


S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
USING RISK NEUTRAL VALUATION (i.e., the binomial option pricing model) find the value
of the call (in euro).
Answer: =


S0 $1.60 = i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Calculate the hedge ratio.
Answer: H = =
pound appreciates

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
State the composition of the replicating portfolio; your answer should contain "trading orders" of
what to buy and what to sell at time zero.
Answer: Buy the present value of 5/9 × £10,000 partly financed by borrowing the pv of 5/9 ×

if the pound appreciates

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Find the value today of your replicating today's portfolio in euro.
Answer:
where the cost of the euro is
less the borrowing inflow
tes

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
If the call finishes out-of-the-money what is your replicating portfolio cash flow?
Answer:

. In the next period, if the pound appreciates

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
If the call finishes in-the-money what is your replicating portfolio cash flow?
Answer:

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
FInd the value of the call.
Answer: = -
The value of our option is correct, computed both with risk neutral valuation and with the
replicating portfolio.
against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by
20 percent.
Spot Rates Risk-Free Rates

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Answer: = ×
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Find the risk neutral probability of an "up" move.
Answer: a = =

20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
USING RISK NEUTRAL VALUATION, find the value of the call (in pounds)
Answer: = = £1,068.38
strengthen
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Calculate the hedge ratio.
Answer:H = =

strengthen
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
State the composition of the replicating portfolio; your answer should contain "trading orders" of
what to buy and what to sell at time zero.
Answer:
Borrow the present value of 5/9 × £8,000
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Find the cost today of your hedge portfolio in pounds.
Answer: £1,068.38 = × -

period, the euro can strengthen
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
If the call finishes out-of-the-money what is your portfolio cash flow?
Answer:
Repay the banker £4,444.44

Portfolio cash flow = £0
e next period, the euro can strengthen

20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
If the call finishes in-the-money what is your portfolio cash flow?
Answer:
Repay the banker £4,444.44

portfolio cash flow = £2,500
he next period, the euro can strengthen
20 percent.

S0 i$3.00%
S0($/£) $2.00 = £1.00 i 4.00%
S0 i£4.00%
Find the value of the call.
Answer: = = £1,068.38
£1,068.38 = × -
The value of our option is correct, computed both with rise neutral valuation and with the
replicating portfolio.
94) Find the dollar value today of a 1-period at-the-money call option on ¥300,000. The spot
exchange rate is ¥100 = $1.00. In the next period, the yen can increase in dollar value by 15
percent or decrease by 15 percent. The risk-free rate in dollars is i$ = 5%; The risk-free rate in
yen is i¥ = 1%.
Answer: To find the risk neutral probability, equate the value of ¥300,000 at the IRP forward
rate to the expected value p × $3,450 + (1 - p) × $2,550

International Financial Management, 8e (Eun)
Chapter 8 Management of Transaction Exposure
1) Transaction exposure is defined as

A) the sensitivity of realized domestic currency values of the firm's contractual cash flows
denominated in foreign currencies to unexpected exchange rate changes.
B) the extent to which the value of the firm would be affected by unanticipated changes in
exchange rate.
C) the potential that the firm's consolidated financial statement can be affected by changes in
exchange rates.
D) ex post and ex ante currency exposures.
Answer: A
Topic: Three Types of Exposure
2) The most direct and popular way of hedging transaction exposure is by

A) exchange-traded futures options.
B) currency forward contracts.
C) foreign currency warrants.
D) borrowing and lending in the domestic and foreign money markets.
Answer: B
3) If you have a long position in a foreign currency, you can hedge with
A) a short position in an exchange-traded futures option.
B) a short position in a currency forward contract.
C) a short position in foreign currency warrants.
D) borrowing (not lending) in the domestic and foreign money markets.
Answer: B
4) If you owe a foreign currency denominated debt, you can hedge with
A) a long position in a currency forward contract.
B) a long position in an exchange-traded futures option.
C) buying the foreign currency today and investing it in the foreign county.
D) a long position in a currency forward contract, or buying the foreign currency today and
investing it in the foreign county.
Answer: D
5) If you own a foreign currency denominated bond, you can hedge with
A) a long position in a currency forward contract.
B) a long position in an exchange-traded futures option.
C) buying the foreign currency today and investing it in the foreign county.
D) a swap contract where pay the cash flows of the bond in exchange for dollars.
Answer: D
6) The sensitivity of "realized" domestic currency values of the firm's contractual cash flows
denominated in foreign currency to unexpected changes in the exchange rate is
A) transaction exposure.
B) translation exposure.
C) economic exposure.
Answer: A
7) The sensitivity of the firm's consolidated financial statements to unexpected changes in the
exchange rate is
Answer: B
8) The extent to which the value of the firm would be affected by unexpected changes in the
exchange rate is
Answer: C
9) With any hedge,
A) your losses on one side should about equal your gains on the other side.
B) you should try to make money on both sides of the transaction; that way you make money
coming and going.
C) you should spend at least as much time working the hedge as working the underlying deal
itself.
D) you should agree to anything your banker puts in front of your face.
Answer: A
10) With any successful hedge,

A) you are guaranteed to lose money on one side.
B) you can avoid the accounting ramifications of a loss on one side by keeping it off the books.
C) you are guaranteed to lose money on one side, but you can avoid the accounting ramifications
of a loss on one side by keeping it off the books.
Answer: D
11) The choice between a forward market hedge and a money market hedge often comes down to
A) interest rate parity.
B) option pricing.
C) flexibility and availability.
Answer: A
12) Since a corporation can hedge exchange rate exposure at low cost
A) there is no benefit to the shareholders in an efficient market.
B) shareholders would benefit from the risk reduction that hedging offers.
C) the corporation's banker would benefit from the risk reduction that hedging offers.
Answer: C
13) A CFO should be least worried about
Answer: B
14) Exchange rate risk of a foreign currency payable is an example of

Answer: A
15) A stock market investor would pay attention to

A) anticipated changes in exchange rates that have been already discounted and reflected in the
firm's value.
B) unanticipated changes in exchange rates that have not been discounted and reflected in the
firm's value.
C) anticipated changes in exchange rates that have been already discounted and reflected in the
firm's value, as well as unanticipated changes in exchange rates that have not been discounted
and reflected in the firm's value.
Answer: A
payable in one year. The money market interest rates and foreign exchange rates are given as
follows:
The U.S. one-year interest rate: 6.10% per annum

The euro zone one-year interest rate: 9.00% per annum
The spot exchange rate: $ 1.50
The one-year forward exchange rate $ 1.46
exchange for a predetermined amount of U.S. dollars. Which of the following is/are true? On the
maturity date of the contract Boeing will
(ii) take delivery of $14.6 million

(iii) have a zero net euro exposure
(iv) have a profit, or a loss, depending on the future changes in the exchange rate, from this
British sale.
A) (i) and (iv)
B) (ii) and (iv)
C) (ii), (iii), and (iv)
D) (i), (ii), and (iii)
Answer: D
because the euro receivable offsets the euro payable.

Topic: Forward Market Hedge
17) Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and b
payable in one year. The money market interest rates and foreign exchange rates are given as
follows:
The U.S. one-year interest rate: 6.10% per annum

The euro zone one-year interest rate: 9.00% per annum
The spot exchange rate: $ 1.50
The one-year forward exchange rate $ 1.46
exchange for a predetermined amount of U.S. dollars. Suppose that on the maturity date of the
f
Which of the following is true?
A) Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered
into the forward contract.
B) Boeing gained $0.6 million from forward hedging.
C) Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered
into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging.
Answer: C

18) Your firm is a U.K.-based exporter of British bicycles. You have sold an order to an Italian
months. Your firm wants to hedge the receivable into pounds. Not dollars. Use the following
table for exchange rate data.
Country U.S.S equiv. Currency per U.S.$

Tuesday Monday Tuesday Monday
Britain(pound)£62,500 1.6000 1.6100 0.625 0.6211
1 Month Forward 1.6100 1.6300 0.6211 0.6173
3 Months Forward 1.6300 1.6600 0.6173 0.6024
6 Months Forward 1.6600 1.7200 0.6024 0.5814
12 Months Forward 1.7200 1.8000 0.5814 0.5556
1.2000 1.2000 0.833333 0.833333
1 Month Forward 1.2100 1.2100 0.82645 0.82645
3 Months Forward 1.2300 1.2300 0.813008 0.813008
6 Months Forward 1.2600 1.2600 0.793651 0.793651
12 Months Forward 1.2900 1.3200 0.775194 0.7575758
Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an
estimate of how many contracts of what type.
A)
receive £728,155.34.
contracts at $1.60 per £1.
forward using 12 contracts at the forward rate of $1.72 per £1.
Answer: D
one year. Spot and forward exchange
rate data is given:
Spot exchange rates 1-year Forward Rates Contract size

$ 1.20 = 1.00 $ 1.25 = 1.00 62,500
$ 1.00 = ¥ 100 $ 1.00 = ¥ 120 ¥ 12,500,000
The one-year risk free rates are i$ = 4.03%; i = 6.05%; and i¥ = 1%. Detail a strategy using
forward contracts
A)
at spot, receive ¥116,504,854.
forward using 11.52 contracts, at the forward rate of $1.00 = ¥120.

0,000
forward using 12 contracts, at the forward rate of $1.00 = ¥120.
Answer: C
20) Your firm has a British customer that is willing to place a $1 million order, but wants to pay
in pounds instead of dollars. The spot exchange rate is $1.85 = £1.00 and the one-year forward
rate is $1.90 = £1.00. The lead time on the order is such that payment is due in one year. What is
the fairest exchange rate to use?
A) $1.85 = £1.00
B) $1.8750 = £1.00
C) $1.90 = £1.00
Answer: C
21) Your firm has a British customer that is willing to place a $1 million order (with payment
due in 6 months), but insists upon paying in pounds instead of dollars.
A) The customer essentially wants you to discount your price by the value of a put option on
pounds.
B) The customer essentially wants you to discount your price by the value of a call option on
pounds.
C) The customer essentially wants you to discount your price by the sum of the values of a call
and put option on pounds.
Answer: D
22) Your firm is a U.K.-based exporter of British bicycles. You have sold an order to an
American firm for $1,000,000 worth of bicycles. Payment from the American firm (in U.S.
dollars) is due in six months. Detail a strategy using futures contracts that will hedge your
exchange rate risk.
Country U.S.$ equiv. Currency per U.S.$

Britain(pound)£62,500 1.8000 1.8100 0.5556 0.5525
1 Month Forward 1.8100 1.8300 0.5525 0.5464
3 Months Forward 1.8300 1.8600 0.5464 0.5376
6 Months Forward 1.8600 1.8200 0.5376 0.5495
12 Months Forward 1.8200 1.8000 0.5495 0.5556
A) Go short 12 six-month forward contracts; pay £555,600.
B) Go short 16 six-month forward contracts. Pay approximately £537,600.
C) Go long 12 six-month forward contracts. Receive approximately £549,500.
D) Go long 16 six-month forward contracts; raise approximately £537,600.
Answer: D
Explanation: You should use 16 contracts, given $1,000,000 / £62,500 = 16. Next, (£1 / $1.86)
× $1,000,000 = £537,634
23) Your firm is a U.S.-based exporter of bicycles. You have sold an order to a French firm for
estimate of how many contracts of what type and how much (in $) your firm will have.
Country U.S.$ equiv. Currency per U.S.$

Britain(pound)£62,500 1.6000 1.6100 0.625 0.6211
1 Month Forward 1.6100 1.6300 0.6211 0.6173
3 Months Forward 1.6300 1.6600 0.6173 0.6024
6 Months Forward 1.6600 1.7200 0.6024 0.5814
12 Months Forward 1.7200 1.8000 0.5814 0.5556
A) Go short 12 six-month forward contracts; pay $1,630,000.
B) Go short 16 six-month forward contracts; pay $1,630,000.
C) Go long 16 six-month forward contracts; raise $1,660,000.
D) Go long 12 six-month forward contracts; receive $1,660,000.
Answer: B
-month
forward rate is $1.63 per euro. Therefor
24) Your firm is a U.K.-based exporter of bicycles. You have sold an order to a French firm for
months.
estimate of how many contracts of what type and maturity.
U.S. $ equiv. Currency per U.S. $

Contract Size Country Tuesday Monday Tuesday Monday
Britain
£ 10,000 $ 1.9600 $1.9400 £ 0.5102 £ 0.5155
(pound)
1 month
$ 1.9700 $1.9500 £ 0.5076 £ 0.5128
forward
3 months
$ 1.9800 $1.9600 £ 0.5051 £ 0.5102
forward
6 months
$ 1.9900 $1.9700 £ 0.5025 £ 0.5076
forward
12
months $ 2.0000 $1.9800 £ 0.5000 £ 0.5051
forward
10,000 Euro $ 1.5600 $1.5400 0.6410 0.6494
1 month
$ 1.5700 $1.5500 0.6369 0.6452
forward
3 months
$ 1.5800 $1.5600 0.6329 0.6410
forward
6 months
$ 1.5900 $1.5700 0.6289 0.6369
forward
12
months $ 1.6000 $1.5800 0.6250 0.6329
forward
Swiss SFr
SFr. 10,000 $ 0.9200 $0.9000 SFr. 1.0870 1.1111
franc .
1 month SFr
$ 0.9400 $0.9200 SFr. 1.0638 1.0870
forward .
3 months SFr
$ 0.9600 $0.9400 SFr. 1.0417 1.0638
forward .
6 months SFr
$ 0.9800 $0.9600 SFr. 1.0204 1.0417
forward .
12
SFr
months $ 1.0000 $0.9800 SFr. 1.0000 1.0204
.
forward
A) Go short 100 12-month euro futures contracts; and short 80 12-month pound futures
contracts.
B) Go long 100 12-month euro futures contracts; and long 80 12-month pound futures contracts.
C) Go long 100 12-month euro futures contracts; and short 80 12-month pound futures contracts.
D) Go short 100 12-month euro futures contracts; and long 80 12-month pound futures contracts.
E) none of the options
Answer: D
the proportion for X: ($1,600,000 / X) = ($2 / £1), where X = £800,000. Next, £800,000 / £10,000
= 80 contracts.

CH 77

Uploaded by

Copyright:

Available Formats

CH 77

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 77

Uploaded by

Copyright:

Available Formats

International Financial Management, 8e (Eun)

Chapter 7 Futures and Options on Foreign Exchange

A) is an example of a forward contract.

4) In reference to the futures market, a "speculator"

6) Comparing "forward" and "futures" exchange contracts, we can say that

7) In which market does a clearinghouse serve as a third party to all transactions?

D) none of the options

D) none of the options

16) What paradigm is used to define the futures price?

Exchange Rate Interest Rate APR

in one year for $14,800).

18) Which equation is used to define the futures price?

21) Open interest in currency futures contracts

D) none of the options

25) A European option is different from an American option in that

(i) buy the stock and hold it for 60 days

A) (i), (ii), and (iii)

28) Most exchange traded currency options

Philadelphia Exchange Puts

Which combination of the following statements are true?

31) With currency futures options the underlying asset is

32) Exercise of a currency futures option results in

-month forward rate is $1.60 =

35) The current spot -month forward rate is $1.60 =

-month forward rate is $1.60 =

values of A, B, and C, respectively?

A) A = $3,125 (or $.05 depending on your scale); B = $1.50; C = $1.55

C) A = $.05; B = $1.55; C = $1.60

-month U.S. dollar interest rate is 2

41) American call and put premiums

42) Which of the following is correct?

43) Which of the following is correct?

45) For European options, what is the effect of an increase in St?

A) time value and intrinsic value.

A) Decreases the value of calls and puts ceteris paribus

And thereby the value call is

Topic: Binomial Option-Pricing Model

Topic: Binomial Option-Pricing Model

Topic: Binomial Option-Pricing Model

C) both of the options

C) both of the options

Topic: Binomial Option-Pricing Model

maturity of the option that prevails today (i.e

maturity of the option that prevails today (i.e

64) With regard to expiration date,

65) With regard to trading location,

66) With regard to contractual size,

67) With regard to trading costs,

69) Find the input d1 of the Black-Scholes price of a six-

72) Find the Black-Scholes price of a six-

74) Empirical tests of the Black-Scholes option pricing formula

75) Empirical tests of the Black-Scholes option pricing formula

Spot Rates Risk-free Rates

Topic: Binomial Option-Pricing Model

Spot Rates Risk-free Rates

Find the risk neutral probability of an "up" move.

Topic: Binomial Option-Pricing Model

next period, if the pound appreciates