Chapter 2

Foreign Exchange Market

A. Spot Market
1. From a Frenchman's point of view, which of each pair of quotes is the direct quote?
Which is the indirect quote?

a. GBP/EUR 1.17; EUR/GBP 0.85

b. USD/EUR 0.88; EUR/USD 1.13

2. You are given the following spot quote: USD/CHF 1.0042–46.

a. What is the base currency? What is the quote currency?

b. If you want to buy 1000 CHF, how many USD do you have to pay for the bank? If you
want to sell 1000 CHF, how many USD do you get from the bank?

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3. A bank quotes the following rates. Compute the USD/GBP cross rate:

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Bid Ask

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GBP/EUR 1.1696 1.1701

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USD/EUR 0.8833 0.8835
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4. Given the bid-ask quotes for GBP/JPY 160–180, at what rate will:

(a) Mr. Smith purchase GBP?

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(b) Mr. Brown sell GBP?

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(c) Mrs. Green purchase JPY?

(d) Mrs. Jones sell JPY?

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5. Assume that a bank’s bid rate on Japanese yen is $0.0041 and its ask rate is
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$0.0043. What is its bid-ask spread in percentage terms (round to two decimal
places if necessary)?
6. Assume that the Canadian dollar (CAD) is equal to USD 0.8800 and the
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Argentine peso (ARS) is equal to USD 0.3500. What is the approximate value of the
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Argentine peso in terms of Canadian dollars (ARS/CAD)?

B. Forward Market
1. Compute the forward discount or premium for the Mexican peso whose 90-day forward
rate is $.102 and spot rate is $.10. State whether your answer is a discount or premium.

2. Calculate the forward discount for the Pound if the spot rate is £/$ 1.5800 and the six-
month forward rate is £/$ 1.5550.

3. Use the following spot and forward bid-ask rates for the U.S. dollar/ Japanese yen ($/¥)
exchange rate from September 16, 2010, to answer the following questions:

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 $/¥ $/¥
Period Bid Rate Ask Rate
spot 85.41 85.46
1 month 85.02 85.05
2 months 84.86 84.90
3 months 84.37 84.42
6 months 83.17 83.20
12 months 82.87 82.91
24 months 81.79 81.82

a. What is the annual forward premium for all maturities?

b. Which maturities have the smallest and largest forward premiums?

4. You have just sold a large shipment of goods from a German firm for 1,000,000 euros (€)
receivable in six months. The current rate of exchange is €/USD 1.2342 and the six-month
forward rate is €/USD 1.2508.

a. How much would you receive if you used a forward hedge?

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b. A six-month put option on euros can be purchased for 2 cents per euro with a strike price

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of USD 1.25 per euro. How much would an option hedge net you (net and in six months) if

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the euro closes at $1.2562 per euro on settlement date?

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C. Futures Market
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1. Assume that one year ago, you sold a futures contract of £10,000,000. At that time, the
spot rate was £/$ = 1.8 and the one-year futures contract of the British pound exhibited a
discount of 5%. From one year ago to today, the pound’s value depreciated against the dollar
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by 4.5 percent. Calculate your profit (loss).

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2. Assume that a March futures contract on Mexican pesos was available in January for $.09
per unit. Also assume that forward contracts were available for the same settlement date at
a price of $.092 per peso. How could speculators capitalize on this situation, assuming zero
transaction costs? How would such speculative activity affect the difference between the
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forward contract price and the futures price?

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D. Options Market
1. Speculating with Currency Call Options. LSU Corp. purchased Canadian dollar call
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options for speculative purposes. If these options are exercised, LSU will immediately sell the
Canadian dollars in the spot market. Each option was purchased for a premium of $.03 per
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unit, with an exercise price of $.75. LSU plans to wait until the expiration date before
deciding whether to exercise the options. Of course, LSU will exercise the options at that time
only if it is feasible to do so. In the following table, fill in the net profit (or loss) per unit to
LSU Corp. based on the listed possible spot rates of the Canadian dollar on the expiration
date.

POSSIBLE SPOT RATE OF CANADIAN DOLLAR NET PROFIT (LOSS) PER UNIT
ON EXPIRATION DATE TO LSU CORP.
$.76
.78
.80
.82

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 .85
.87

2. Speculating with Currency Put Options. Auburn Co. has purchased Canadian dollar
put options for speculative purposes. Each option was purchased for a premium of $.02 per
unit, with an exercise price of $.86 per unit. Auburn Co. will purchase the Canadian dollars
just before it exercises the options (if it is feasible to exercise the options). It plans to wait
until the expiration date before deciding whether to exercise the options. In the following
table, fill in the net profit (or loss) per unit to Auburn Co. based on the listed possible spot
rates of the Canadian dollar on the expiration date.

POSSIBLE SPOT RATE OFCANADIAN DOLLAR NET PROFIT (LOSS) PER UNIT
ON EXPIRATION DATE TO AUBURN CO.
$.76
.79
.84
.87
.89

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3. Speculating with Currency Call Options. Bama Corp. has sold British pound call

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options for speculative purposes. The option premium was $.06 per unit, and the exercise

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price was $1.58. Bama will purchase the pounds on the day the options are exercised (if the
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options are exercised) in order to fulfill its obligation. In the following table, fill in the net
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profit (or loss) to Bama Corp. if the listed spot rate exists at the time the purchaser of the call
options considers exercising them.
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POSSIBLE SPOT RATE AT THE TIME PURCHASER OF NET PROFIT (LOSS) PER
CALL OPTIONS CONSIDERS EXERCISING THEM UNIT TO BAMA CORP.
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$1.53
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1.55
1.57
1.60
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1.62
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1.64

4. Speculating with Currency Put Options. Bulldog, Inc., has sold Australian dollar put
options at a premium of $.01 per unit, and an exercise price of $.76 per unit. It has forecasted
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the Australian dollar’s lowest level over the period of concern as shown in the following table.
Determine the net profit (or loss) per unit to Bulldog, Inc., if each level occurs and the put
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options are exercised at that time.

NET PROFIT (LOSS) TO BULLDOG, INC. IF VALUE OCCURS

$.72
.73
.74
.75
.76

5. The spot rate of the New Zealand dollar is $.70. A call option on New Zealand dollars with
a 1-year expiration date has an exercise price of $.71 and a premium of $.02. A put option on

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 New Zealand dollars at the money with a 1-year expiration date has a premium of $.03. You
expect that the New Zealand dollar’s spot rate will rise over time and will be $.75 in 1 year.
a. Today, Jarrod purchased call options on New Zeal- and dollars with a 1-year expiration
date. Estimate the profit or loss per unit for Jarrod at the end of 1 year. [Assume that the
options would be exercised on the expiration date or not at all.]
b. Today, Laurie sold put options on New Zealand dollars at the money with a 1-year
expiration date. Estimate the profit or loss per unit for Laurie at the end of 1 year. [Assume
that the options would be exercised on the expiration date or not at all.]

6. You often take speculative positions in options on euros. One month ago, the spot rate of
the euro was $1.49, and the 1-month forward rate was $1.50. At that time, you sold call
options on euros at the money. The premium on that option was $.02. Today is when the
option will be exercised if it is feasible to do so.
a. Determine your profit or loss per unit on your option position if the spot rate of the euro is
$1.55 today.
b. Repeat question a, but assume that the spot rate of the euro today is $1.48.

7. One year ago, you sold a € put option with details as below:

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- Premium: $.04 per unit

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- Strike price: $1.22

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- Contract size: 100,000 €

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Assume one year ago: rs e
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- Spot rate: 1€ = $1.20

- One-year forward rate exhibited a discount of 2%, and the one-year futures price was the
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same as the one-year forward rate

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- Assume from one year ago to today the euro depreciated against the dollar by 4 percent

a. Assume that your counterparty will exercise the put option today. Calculate your profit/loss

b. Assume that instead of taking a position in the put option one year ago, you sold a futures
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contract on 100,000 euros with a settlement date of one year. Determine your profit/ loss.
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