Problem 7.

1 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 spot rate is $0.12000/Ps?
b. What is the value of her position at maturity if the ending spot rate is $0.09800/Ps?
c. What is the value of her position at maturity if the ending spot rate 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 7.2 Peleh's Puts

Peleh writes a put option on Japanese yen 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. What is Peleh'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 7.3 Ventosa Investments

Jamie Rodriguez, a currency trader for Chicago-based Ventosa Investments, uses the following futures quotes on the British pound () to speculate on the value of
the 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 Jaime buys 5 June pound futures, and the spot rate at maturity is $1.3980/, what is the value of her position?
b. If Jamie sells 12 March pound futures, and the spot rate at maturity is $1.4560/, what is the value of her position?
c. If Jamie buys 3 March pound futures, and the spot rate at maturity is $1.4560/, what is the value of her position?
d. If Jamie sells 12 June pound futures, and the spot rate at maturity is $1.3980/, 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 she 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: Jamie 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: Jamie 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 7.4 Sallie Schnudel

Sallie Schnudel trades currencies for Keystone Funds in Jakarta. She focuses nearly all of her time and attention on the U.S.
dollar/Singapore dollar ($/S$) cross-rate. The current spot rate is $0.6000/S$. After considerable study, she has concluded
that the Singapore dollar will appreciate versus the U.S. dollar in the coming 90 days, probably to about $0.7000/S$. She
has the following options on the Singapore dollar to choose from:

Option Strike Price Premium

Put on Sing $ $0.6500/S$ $0.00003/S$
Call on Sing $ $0.6500/S$ $0.00046/S$

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?

b. What is Sallie's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Sallie's gross profit and net profit (including premium) if the spot rate at the
end of 90 days is indeed $0.7000/S$?
d. Using your answer from part (a), what is Sallie's gross profit and net profit (including premium) if the spot rate at the
end of 90 days is $0.8000/S$?

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 Sallie buy a put on Singapore dollars or a call on Singapore dollars?

Since Sallie expects the Singapore dollar to appreciate versus the US dollar, she should buy a call on Singapore dollars.
This gives her 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 her expectation of the future spot rate proves correct.)

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

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. What is Sallie'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 $0.70000 $0.70000
Less strike price ($0.65000) ($0.65000)
Less premium ($0.00046)
Profit $0.05000 $0.04954

d. What is Sallie'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 $0.80000 $0.80000
Less strike price ($0.65000) ($0.65000)
Less premium ($0.00046)
Profit $0.15000 $0.14954
Problem 7.9 Vatic Capital

Cachita Haynes works as a currency speculator for Vatic 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:

Option Strike Price Premium

Put on yen 125/$ $0.00003/S$
Call on yen 125/$ $0.00046/S$

a. Should Cachita buy a put on yen or a call on yen?

b. What is Cachita's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Cachita's gross profit and net profit (including premium) if the
spot rate at the end of 90 days is 140/$?

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?

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

b. What is Cachita's break even price on her option of choice in part a)?
Cachita 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 Cachita'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 7.10 Calling All Profits

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 .....

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 7.15 Chrysler LLC

Chrysler LLC, the now privately held company sold-off by DaimlerChrysler, must pay floating rate interest
three months from now. It wants to lock in these interest payments by buying an interest rate futures contract.
Interest rate futures for three months from now settled at 93.07, for a yield of 6.93% per annum.

a. If the floating interest rate three months from now is 6.00%, what did Chrysler gain or lose?
b. If the floating interest rate is 8.00% three months from now, what did Chrysler gain or lose?

Assumptions Values
Interest rate futures, closing price 93.07
Effective yield on interest rate futures 6.930%

Three Months From Now

Floating Rate is Floating Rate is
Chrysler's interest rate payments with futures 6.000% 8.000%

Interest payment due in three months 6.000% 8.000%

Sell a future (take a short position) -6.930% -6.930%
Gain or loss on position -0.930% 1.070%
Loss Gain
Problem 7.17 Lluvia and Paraguas

Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would
prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate
borrowing. Lluvia is the more credit-worthy company. They face the following rate structure. Lluvia,
with the better credit rating, has lower borrowing costs in both types of borrowing.

Lluvia wants floating rate debt, so it could borrow at LIBOR+1%. However it could borrow fixed at
8% and swap for floating rate debt. Paraguas wants fixed rate, so it could borrow fixed at 12%. However
it could borrow floating at LIBOR+2% and swap for fixed rate debt. What should they do?

Assumptions Xavier Zulu

Credit rating AAA BBB
Prefers to borrow Floating Fixed
Fixed-rate cost of borrowing 8.000% 12.000%
Floating-rate cost of borrowing:
LIBOR (value is unimportant) 5.000% 5.000%
Spread 1.000% 2.000%
Total floating-rate 6.000% 7.000%

Comparative Advantage in Borrowing Values

Lluvia's absolute advantage:
in fixed rate borrowering 4.000%
in floating-rate borrowing 1.000%
Comparative advantage in fixed rate 3.000%

The 3.0% comparative advantage enjoyed by Lluvia represents the opportunity set for improvement for
both parties. This could be a 1.5% savings for each (as in the example shown) or any other combination
which distributes the 3.0% between the two parties.
Problem 7.18 Trident's Cross Currency Swap: SFr for US$

Trident Corporation entered into a three-year cross currency interest rate swap to receive U.S. dollars and pay Swiss francs. Trident, however, decided to
unwind the swap after one year thereby having two years left on the settlement costs of unwinding the swap after one year. Repeat the calculations for
unwinding, but assume that the following rates now apply:

Assumptions Values Swap Rates 3- year bid 3-year ask

Notional principal $ 10,000,000 Original: US dollar 5.56% 5.59%
Original spot exchange rate, SFr./$ 1.5000 Original: Swiss franc 1.93% 2.01%
New (1-year later) spot exchange rate, SFr./$ 1.5560
New fixed US dollar interest 5.20%
New fixed Swiss franc interest 2.20%

a. Interest & Swap Payments Year 0 Year 1 Year 2 Year 3

Receive fixed rate dollars at this rate: 5.56% 5.56% 5.56%

On a notional principal of: $ 10,000,000
Trident will receive cash flows: ### ### ###

Exchange rate, time of swap (SFr./$) 1.5000

Trident will pay cash flows: SFr. 301,500 SFr. 301,500 SFr. 15,301,500
On a notional principal of: SFr. 15,000,000
Pay fixed rate Swiss francs at this rate: 2.01% 2.01% 2.01%

b. Unwinding the swap after one-year Year 1 Year 2 Year 3

Remaining dollar cash inflows $ 556,000 $ 10,556,000

PV factor at now current fixed $ interest 5.20% 0.9506 0.9036
PV of remaining dollar cash inflows $ 528,517 $ 9,538,232
Cumulative PV of dollar cash infllows $ 10,066,750

Remaining Swiss franc cash outflows SFr. 301,500 SFr. 15,301,500

PV factor at now current fixed SF interest 2.20% 0.9785 0.9574
PV of remaining SF cash outflows SFr. 295,010 SFr. 14,649,818
Cumulative PV of SF cash outflows SFr. 14,944,827
New current spot rate, SFr./$ 1.5560
Cumulative PF of SF cash outflows in $ $ 9,604,645

Settlement:
Cash inflow $ 10,066,750
Cash outflow (9,604,645)
Net cash settlement of unwinding $ 462,105 This is a cash receipt by Trident from the swap dealer.
Problem 7.20 Falcor

Falcor is the U.S.-based automotive parts supplier which was spun-off from General Motors in 2000. With annual sales of over $26 billion, the company has expanded its markets
far beyond the traditional automobile manufacturers in the pursuit of a more diversified sales base. As part of the general diversification effort, the company wishes to diversify
the currency of denomination of its debt portfolio as well. Assume Falcor enters into a $50 million 7-year cross currency interest rate swap to do just that pay euro and receive
dollars. Using the data in Exhibit 8.13,

a. Calculate all principal and interest payments in both currencies for the life of the swap.

b. Assume that three years later Falcor decides to unwind the swap agreement. If 4-year fixed rates of interest in euros have now risen to 5.35% and 4-year fixed rate dollars have
fallen to 4.40%, and the current spot exchange rate of $1.02/, what is the net present value of the swap agreement? Who pays who what?

Assumptions Values Swap Rates 7- year bid 7-year ask

Notional principal $ 50,000,000 US dollar 5.86% 5.89%
Spot exchange rate, $/ 1.16 Euros 4.01% 4.05%

a. Interest & Swap Payments Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

Receive fixed rate dollars at rate: 5.86%

Notional principal of: $ 50,000,000
Receive cash inflows of: $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 52,930,000

Spot exchange rate, $/ 1.16

Pay cash outflows of: 1,745,690 1,745,690 1,745,690 1,745,690 1,745,690 1,745,690 44,849,138
Notional principal of: 43,103,448
Pay fixed rate euros at rate: 4.05%

b. Unwindingthe Swap Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

If the swap is unwound three years later, there are four years of cash flows remaining:

Remaining dollar cash inflows $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 52,930,000

PV factor at now current fixed $ interest 4.40% 0.9579 0.9175 0.8788 0.8418
PV of remaining dollar cash inflows $ 2,806,513 $ 2,688,231 $ 2,574,934 $ 44,555,354
Cumulative PV of $ cash infllows $ 52,625,033

Remaining euro cash outflows 1,745,690 1,745,690 1,745,690 44,849,138

PV factor at now current fixed interest 5.35% 0.9492 0.9010 0.8553 0.8118
PV of remaining euro cash outflows 1,657,038 1,572,889 1,493,012 36,409,603
Cumulative PV of cash outflows 41,132,542
Spot exchange rate at unwinding ($/) 1.02
Cumulative PV of cash outflows, $ $ 41,955,193

Settlement:
Cash inflow $ 52,625,033
Cash outflow (41,955,193)
Net cash settlement of unwinding $ 10,669,840 This is a net cash payment to Falcor from the swap dealer.