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23) The buyer (long) of a put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the
premium paid.
D) all of the above
24) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.
25) The writer of the option is referred to as the seller, and the buyer of the option is referred to
as the holder.
26) Foreign currency options are available both over-the-counter and on organized exchanges.
27) Most option profits and losses are realized through taking actual delivery of the currency
rather than offsetting contracts.
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28) Compare and contrast foreign currency options and futures. Identify situations when you
may prefer one vs. the other when speculating on foreign exchange.
7.3 Option Pricing and Valuation
1) Which of the following is NOT a factor in determining the premium price of a currency
option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.
2) The ________ of an option is the value if the option were to be exercised immediately. It is
the option’s ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum
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3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call
option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.
4) If the spot rate changes from $1.70/£ to $1.71/£ and there is an option with an initial premium
of $0.033/£ and a delta of 0.5, then the new option premium would be:
A) $0.043/£.
B) $0.038/£.
C) $0.005/£.
D) $1.715/£.
5) As an option moves further in-the-money delta moves toward:
A) 0.
B) -1.
C) 1.
D) large numbers.
6) As an option moves further out-of-the-money, delta moves toward:
A) 1..
B) 0.
C) -1.
D) large negative numbers.
7) Option premiums deteriorate at an/a ________ as they approach expiration.
A) increasing rate
B) proportional
C) decreasing rate
D) less than proportional rate
8) Volatility is viewed the following ways EXCEPT:
A) historic
B) forward-looking
C) implied
D) spot
9) For a $1.50/£ call option with an initial premium of $0.033/£ and a lambda of 0.4, after an
increase in annual volatility of 1 percent point – for example from 10% to 11% – the new option
premium would be:
A) $0.036/£.
B) $0.037/£.
C) $0.004/£.
D) $1.54/£.
10) Traders who believe volatilities will fall significantly in the near-term will:
A) sell futures now.
B) buy options now.
C) sell options now.
D) buy futures now.
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11) For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an
increase in the U.S. dollar rate from 8% to 9% – the new ATM option premium would be:
A) $0.037/£.
B) $1.55/£.
C) $0.036/£.
D) $0.035/£.
12) For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an
increase in the foreign interest (the pound sterling rate) rate from 8% to 9% – the new option
premium would be:
A) $0.035/£.
B) $1.48/£.
C) $0.031/£.
D) $0.032/£.
13) The Delta of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
14) The Theta of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
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15) The Lambda of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
16) The Rho of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
17) The Phi of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
18) Which of the following statements is NOT true about currency option pricing sensitivities?
A) The higher the delta, the more likely the option will move in-the-money
B) Premiums rise with increases in volatility
C) Premiums are relatively insensitive during the first days
D) Increases in domestic interest rates cause decreasing call option premiums
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19) The time value is asymmetric in value as you move away from the strike price (i.e., the time
value at two cents above the strike price is not necessarily the same as the time value two cents
below the strike price).
20) The price of an option is always somewhat greater than its intrinsic value, since there is
21) The time value is asymmetric in value as you move away from the strike price (i.e., the time
value at two cents above the strike price is not necessarily the same as the time value two cents
22) Standard foreign currency options are priced around the forward rate.
23) As long as the option has time remaining before expiration, the option will possess time the
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24) If an American-style option possesses time value on any day up to expiration date, the option
holder would get more by selling it than exercising it.
25) The value of any option that is currently in-the-money (ITM) is made up entirely of time
26) The sensitivity of the option premium to a small change in the spot exchange rate is called
the gamma.
27) If the rho of the specific option is known, it is easy to determine how the option’s value will
change as the spot rate changes.
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29) Option values increase with the length of time to maturity. The expected change in the option
premium from a small change in the time to expiration is termed delta.
30) The majority of the option premium is lost in the final days prior to expiration.
31) A trader who is buying options of longer maturities will pay more, and proportionately more,
for the longer maturity options.
32) Option volatility is defined as the square root of the standard deviation of daily percentage
33) If the exchange rate’s volatility is rising, and therefore the risk of the option not being
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34) The primary problem with volatility is that it is unobservable; it is the only input into the
option pricing formula that is determined subjectively by the trader pricing the option.
35) Historical volatility is the correct method for the calculation of the option volatility.
36) Traders by using the historical volatility assume that the immediate future will be the same as
the recent past, and the historical volatility will equal the forward-looking volatility.
37) A trader who is purchasing a call option on foreign currency should do so before the
38) The expected change in the option premium from a small change in the domestic interest rate
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39) The expected change in the option premium from a small change in the foreign interest rate
(foreign currency) is term vega.
40) List and explain three “Greek” elements and impacts on a call option premium.
41) Define and explain the logic for the time value of an option. Explain the value of the time
value of an option for deep out-of-the money and deep in-the-money options.