Question

BF2207 Question 2 Suppose that, six months ago, you sold a call option on 1,000,000 euros (EUR) with an expiration date of six months and an exercise price of 1.1780 United States dollars (USD). You received a premium on the call option of 0.045 USD per unit. Assume the following: • Money market interest rates for EUR are constant through time and equal 5% for all maturities. • Money market interest rates for USD are constant through time and equal 3% for all maturities. • You may borrow and lend at the money market interest rates Six months ago, the spot rate of the EUR was 1.1900 USD and the one-year forward rate exhibited an annualized discount of 2%. • From six months ago to today, the EUR has appreciated against the dollar by 4% (non-annualized). • Futures prices are equal to forward rates. Estimak profits from Today the call option will be exercised (if it is feasible for the buyer to do so). Cal 9 Determine the total USD amount of your profit or loss from your position in the call option (8 marks) (b) Suppose that interest rate parity holds. What is today's six-month forward premium or discount? (6 marks) Now assume that, six months ago, you sold a futures contract on 1,000,000 EUR with a settlement date of one year instead of taking a position in the call option. Suppose you reverse your futures position today, i.e., you buy a futures contract on 1,000,000 EUR with a settlement date of six months to offset your earlier futures position. If interest rate parity holds, determine the total USD amount of your profit or loss. (8 marks) (TOTAL: 22 marks)

Answer 1

Anual. 6 Months al aporeciation in EUR 11€ = 1.198 Today. euros sold € 10,00,000 2% disc, year term = 6 months. exercise price & 1.1780 Premium received $0.045 perunit. Interest rate :- (borrowing and lending rates) EUR = 5% USD = 3% Total money in Hands of writer of call option after 6monthe. — (1900,000 * 0.045 x 37 x 6 ) + (10,00000X 0.049) → 675 + 45,000 45,695 d-1:19 1.9 X 0.04. x = 0.04% 1:19) + 1.19 x = $1.24 exercise price = $ 1.1780 loss = = loss a 1.24 - 1.1780 = 0.06. 0.06% 10,00,000 60,000 Net loss = 45,675 - 60,000 =). (14,325)

(b) EUR = Spot rate on 6months before. 1 EUR = 1.19 USD for wound rate 1 EUR forccord rate = USD) (USD interestrale +1) CEUR interest rate +1) 1.19 + (1+ 0.0346 (1+ 0.05x6 1.2078 - 1784 1.025 11:1794 - 1-19 x 12 x 100 -1.9496 => +2084% Pa 1.19 -1.9496 6 months forward discount = 22084% Peranum. Futures :- sales of futures at the value ress: 6months Eur value } after 6 months / $ 1.1780 (1.1784) = (0.0004) (400) (0.0004) X (10,09000) =) loss in USD = $400 total