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# Revision problem for INS3032

1.Apple will make a payment totaling 1.875 million next month to British suppliers. It can buy pound call
options with a strike price of \$1.64 at a premium of 3.0 cents per pound. The spot price of the pound is currently
\$1.65, and the pound is expected to trade in the range of \$1.62 to \$1.70. Apple also can take a long position in
the pound futures contract with futures price at \$1.65. Apple's treasurer believes that the most likely price of the
pound in 30 days will be \$1.68.

a. How many options and futures contracts will Apple need to protect its payment? Each contract size is
31,250 for options and 62,500 for futures and calculate the breakeven point (5 points)

b. Diagram Apple's profit and loss associated with the call option position and futures position within
its range of expected exchange rates. Ignore transaction costs and margins.( 5 points)

c. Calculate what Apple would gain or lose on the option within the range of expected future
exchange rates at three points: \$1.63, \$1.65 & \$1.70.( 10 points)

2. Apex Corporation must pay its Japanese supplier 125 million in three months. It is thinking of buying 20
yen call options (contract size is 6.25 million) at a strike price of \$0.00800 in order to protect against the risk
of a rising yen. The premium is 0.015 cents per yen. Alternatively, Apex could buy 10 three-month yen futures
contracts (contract size is 12.5 million) at a price of \$0.007940 per yen. The current spot rate is 1 =
\$0.007823. Suppose Apex's treasurer believes that the most likely value for the yen in 90 days is \$0.007900, but
the yen could go as high as \$0.008400 or as low as \$0.007500.

a. What is Apex's break-even future spot price on the option contract? On the futures contract?

b. Diagram Apex's gains and losses on the call option position and the futures position within its range of
expected prices (see Exhibit 8.4). Ignore transaction costs and margins

c. Calculate what Apex would gain or lose on the option and futures positions if the yen settled at its most
likely value

3. 11. James Clark is a foreign exchange trader with Citibank. He notices the following quotes.

## Six-month SFr interest rate 2.0% per year

a. Is the interest rate parity holding? You may ignore transaction costs.

Is there an arbitrage opportunity? If yes, show what steps need to be taken to make arbitrage profit. Assuming
that James Clark is authorized to work with \$1,000,000, compute the arbitrage profit in dollars

4. The one-year interest rate in the U.S. is i\$ = 2% and in the euro zone the one-year interest rate is i = 6%. The
spot exchange rate is \$1.25 = 1.00 and the one-year forward exchange rate is \$1.20 = 1.00. Show how to
realize a certain profit via covered interest arbitrage ( Start with \$1,000,000 or 800,000) ( li 2000 eur hay l
2400 dollar)

5. Assume todays 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.EUR125,000 is the contract size of one EUR contract.

6. Do problem 5 again assuming you have a long position in the futures contract.