Fin431 Final Extra Credit Solutions
This entire homework is worth 2 exam points. Attach/show your work for full credit.
You are a trader in Brazil at the Bolsa exchange writing both Calls and Puts. Call and Put options are available on the US dollar with a strike of 2.2R/$ for a premia of .40R and .20R respectively. Assume each contract controls $100,000. Be sure to draw the payoff and profit/loss diagrams before answering the questions.
1. Which breakeven point is correct?
a. Call 2.0
b. Put 2.4
c. Call 2.4
d. Put 1.8
e. Put 2.0
2. If at maturity, the spot is 1.9R/$ at maturity, which option is exercised?
a. Put, profit 10,000R
b. Call, payoff -30,000R
c. Call, payoff -10,000R
d. Put, payoff -30,000R
e. None of the above
3. Suppose that the spot is 2.3R/$ at maturity, which is true?
a. Call, payoff 10,000P
b. Put, loss 10,000R
c. Call, profit 30,000R
d. Call, loss 30,000R
e. None of the above
4. Suppose that you will be receiving $1,000,000 on Feb 2 (about two months). Which option should you use to hedge its value in Brazilian Real, and what will your effective exchange rate be if on Feb 2, the spot 2.35 R/$. Forward is 2.2R/$.
a. Call, 1.95
b. Put, 2.55
c. Call, 2.60
d. Put, 2.35
e. Put, 2.15
5. Assuming a forward rate of 2.2, at what realized spot would you have been indifferent between using the option in question 4, and a forward contract.
a. 2.6
b. 2.5
c. 2.4
d. 2.3
e. 2.2
Solution:
The put is in-the-money by .3R/$ at 1.9, since you are the writer, you must pay or 30,000R. At 2.3, the call is in-the-money, your payout is .1R/$, leaving you a profit of .3R/$. To hedge the revenue, you buy 10 puts. At 2.35, the puts expire out-of-the-money, your effective exchange rate is 2.35 minus the premium. To be indifferent, your net cost of currency must equal the forward; this occurs at 2.4R/$.
Firm A and Firm B are considering an interest rate swap. Firm A can borrow fixed at 7% or at Libor plus 100BP. Firm B can Borrow fixed at 8% or at Libor plus 250BP. 6. Which is
You are a trader in Brazil at the Bolsa exchange writing both Calls and Puts. Call and Put options are available on the US dollar with a strike of 2.2R/$ for a premia of .40R and .20R respectively. Assume each contract controls $100,000. Be sure to draw the payoff and profit/loss diagrams before answering the questions.
1. Which breakeven point is correct?
a. Call 2.0
b. Put 2.4
c. Call 2.4
d. Put 1.8
e. Put 2.0
2. If at maturity, the spot is 1.9R/$ at maturity, which option is exercised?
a. Put, profit 10,000R
b. Call, payoff -30,000R
c. Call, payoff -10,000R
d. Put, payoff -30,000R
e. None of the above
3. Suppose that the spot is 2.3R/$ at maturity, which is true?
a. Call, payoff 10,000P
b. Put, loss 10,000R
c. Call, profit 30,000R
d. Call, loss 30,000R
e. None of the above
4. Suppose that you will be receiving $1,000,000 on Feb 2 (about two months). Which option should you use to hedge its value in Brazilian Real, and what will your effective exchange rate be if on Feb 2, the spot 2.35 R/$. Forward is 2.2R/$.
a. Call, 1.95
b. Put, 2.55
c. Call, 2.60
d. Put, 2.35
e. Put, 2.15
5. Assuming a forward rate of 2.2, at what realized spot would you have been indifferent between using the option in question 4, and a forward contract.
a. 2.6
b. 2.5
c. 2.4
d. 2.3
e. 2.2
Solution:
The put is in-the-money by .3R/$ at 1.9, since you are the writer, you must pay or 30,000R. At 2.3, the call is in-the-money, your payout is .1R/$, leaving you a profit of .3R/$. To hedge the revenue, you buy 10 puts. At 2.35, the puts expire out-of-the-money, your effective exchange rate is 2.35 minus the premium. To be indifferent, your net cost of currency must equal the forward; this occurs at 2.4R/$.
Firm A and Firm B are considering an interest rate swap. Firm A can borrow fixed at 7% or at Libor plus 100BP. Firm B can Borrow fixed at 8% or at Libor plus 250BP. 6. Which is