Answers to End of Chapter Questions
1. Forward versus Futures Contracts. Compare and contrast forward and futures contracts.
ANSWER: Because currency futures contracts are standardized into small amounts, they can be
2. Using Currency Futures.
a. How can currency futures be used by corporations?
ANSWER: U.S. corporations that desire to lock in a price at which they can sell a foreign currency
b. How can currency futures be used by speculators?
ANSWER: Speculators who expect a currency to appreciate could purchase currency futures
3. Currency Options. Differentiate between a currency call option and a currency put option.
ANSWER: A currency call option provides the right to purchase a specified currency at a specified
4. Forward Premium. 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.
ANSWER: (F – S) / S
5. Effects of a Forward Contract. How can a forward contract backfire?
ANSWER: If the spot rate of the foreign currency at the time of the transaction is worth less than the
6. Hedging With Currency Options. When would a U.S. firm consider purchasing a call option on
euros for hedging? When would a U.S. firm consider purchasing a put option on euros for hedging?
ANSWER: A call option can hedge a firm’s future payables denominated in euros. It effectively
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7. Speculating With Currency Options. When should a speculator purchase a call option on Australian
dollars? When should a speculator purchase a put option on Australian dollars?
ANSWER: Speculators should purchase a call option on Australian dollars if they expect the
8. Currency Call Option Premiums. List the factors that affect currency call option premiums and
briefly explain the relationship that exists for each. Do you think an at-the-money call option in euros
has a higher or lower premium than an at-the-money call option in Mexican pesos (assuming the
expiration date and the total dollar value represented by each option are the same for both options)?
ANSWER: These factors are listed below:
The higher the existing spot rate relative to the strike price, the greater is the call option value,
9. Currency Put Option Premiums. List the factors that affect currency put options and briefly explain
the relationship that exists for each.
ANSWER: These factors are listed below:
The lower the existing spot rate relative to the strike price, the greater is the put option value,
10. Speculating with Currency Call Options. Randy Rudecki purchased a call option on British pounds
for $.02 per unit. The strike price was $1.45 and the spot rate at the time the option was exercised
was $1.46. Assume there are 31,250 units in a British pound option. What was Randy’s net profit on
this option?
ANSWER:
Profit per unit on exercising the option = $.01
11. Speculating with Currency Put Options. Alice Duever purchased a put option on British pounds for
$.04 per unit. The strike price was $1.80 and the spot rate at the time the pound option was exercised
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was $1.59. Assume there are 31,250 units in a British pound option. What was Alice’s net profit on
the option?
ANSWER:
Profit per unit on exercising the option = $.21
12. Selling Currency Call Options. Mike Suerth sold a call option on Canadian dollars for $.01 per
unit. The strike price was $.76, and the spot rate at the time the option was exercised was $.82.
Assume Mike did not obtain Canadian dollars until the option was exercised. Also assume that there
are 50,000 units in a Canadian dollar option. What was Mike’s net profit on the call option?
ANSWER:
Premium received per unit = $.01
13. Selling Currency Put Options. Brian Tull sold a put option on Canadian dollars for $.03 per unit.
The strike price was $.75, and the spot rate at the time the option was exercised was $.72. Assume
Brian immediately sold off the Canadian dollars received when the option was exercised. Also
assume that there are 50,000 units in a Canadian dollar option. What was Brian’s net profit on the put
option?
ANSWER:
Premium received per unit = $.03
14. Forward versus Currency Option Contracts. What are the advantages and disadvantages to a U.S.
corporation that uses currency options on euros rather than a forward contract on euros to hedge its
exposure in euros? Explain why an MNC use forward contracts to hedge committed transactions and
use currency options to hedge contracts that are anticipated but not committed. Why might forward
contracts be advantageous for committed transactions, and currency options be advantageous for
anticipated transactions?
ANSWER: A currency option on euros allows more flexibility since it does not commit one to
The disadvantage of a euro option is that the option itself is not free. One must pay a premium for the
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15. Speculating with Currency Futures. Assume that the euro’s spot rate has moved in cycles over
time. How might you try to use futures contracts on euros to capitalize on this tendency? How could
you determine whether such a strategy would have been profitable in previous periods?
ANSWER: Use recent movements in the euro to forecast future movements. If the euro has been
16. Hedging with Currency Derivatives. Assume that the transactions listed in the first column of the
following table are anticipated by U.S. firms that have no other foreign transactions. Place an “X” in
the table wherever you see possible ways to hedge each of the transactions.
a. Georgetown Co. plans to purchase Japanese goods denominated in yen.
b. Harvard, Inc., sold goods to Japan, denominated in yen.
c. Yale Corp. has a subsidiary in Australia that will be remitting funds to the U.S. parent.
d. Brown, Inc., needs to pay off existing loans that are denominated in Canadian dollars.
e. Princeton Co. may purchase a company in Japan in the near future (but the deal may not go
through).
ANSWER:
Forward Contract Futures Contract Options Contract
Forward Forward Buy Sell Purchase Purchase
Purchase Sale Futures Futures Calls Puts
a. X X X
e.
17. Price Movements of Currency Futures. Assume that on November 1, the spot rate of the British
pound was $1.58 and the price on a December futures contract was $1.59. Assume that the pound
depreciated during November so that by November 30 it was worth $1.51.
a. What do you think happened to the futures price over the month of November? Why?
ANSWER: The December futures price would have decreased, because it reflects expectations of the
b. If you had known that this would occur, would you have purchased or sold a December futures
contract in pounds on November 1? Explain.
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ANSWER: You would have sold futures at the existing futures price of $1.59. Then as the spot rate
18. Speculating with Currency Futures. 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 forward contract price and the futures price?
ANSWER: Speculators could purchase peso futures for $.09 per unit, and simultaneously sell pesos
As many speculators capitalize on the strategy described above, they would place upward pressure on
19. Speculating with Currency Call Options. LSU Corp. purchased Canadian dollar call 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 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.
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ANSWER:
Possible Spot Rate Net Profit (Loss) per
of Canadian Dollar Unit to LSU Corporation
on Expiration Date if Spot Rate Occurs
$.76 –$.02
20. 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.
ANSWER:
Possible Spot Rate Net Profit (Loss) per Unit
of Canadian Dollar to Auburn Corporation
on Expiration Date if Spot Rate Occurs
$.76 $.08
21. Speculating with Currency Call Options. Bama Corp. has sold British pound call options for
speculative purposes. The option premium was $.06 per unit, and the exercise price was $1.58.
Bama will purchase the pounds on the day the options are exercised (if the options are exercised) in
order to fulfill its obligation. In the following table, fill in the net profit (or loss) to Bama Corp. if the
listed spot rate exists at the time the purchaser of the call options considers exercising them.
ANSWER:
Possible Spot Rate at the Net Profit (Loss) per
Time Purchaser of Call Option Unit to Bama Corporation
Considers Exercising Them if Spot Rate Occurs
$1.53 $.06
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22. 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 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 options are exercised at that
time.
ANSWER:
Possible Value Net Profit (Loss) to
of Australian Dollar Bulldog, Inc. if Value Occurs
$.72 –$.03
23. Hedging with Currency Derivatives. A U.S. professional football team plans to play an exhibition
game in the United Kingdom next year. Assume that all expenses will be paid by the British
government, and that the team will receive a check for 1 million pounds. The team anticipates that the
pound will depreciate substantially by the scheduled date of the game. In addition, the National Foot-
ball League must approve the deal, and approval (or disapproval) will not occur for three months.
How can the team hedge its position? What is there to lose by waiting three months to see if the
exhibition game is approved before hedging?
ANSWER: The team could purchase put options on pounds in order to lock in the amount at which it
If the team waits three months, option prices will have changed by then. If the pound has depreciated
over this three-month period, put options with the same exercise price would command higher
Advanced Questions
24. Risk of Currency Futures. Currency futures markets are commonly used as a means of capitalizing
on shifts in currency values, because the value of a futures contract tends to move in line with the
change in the corresponding currency value. Recently, many currencies appreciated against the dollar.
Most speculators anticipated that these currencies would continue to strengthen and took large buy
positions in currency futures. However, the Fed intervened in the foreign exchange market by
immediately selling foreign currencies in exchange for dollars, causing an abrupt decline in the values
of foreign currencies (as the dollar strengthened). Participants that had purchased currency futures
contracts incurred large losses. One floor broker responded to the effects of the Fed’s intervention by
immediately selling 300 futures contracts on British pounds (with a value of about $30 million). Such
actions caused even more panic in the futures market.
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a. Explain why the central bank’s intervention caused such panic among currency futures traders
with buy positions.
ANSWER: Futures prices on pounds rose in tandem with the value of the pound. However, when
b. Explain why the floor broker’s willingness to sell 300 pound futures contracts at the going market
rate aroused such concern. What might this action signal to other brokers?
ANSWER: Normally, this order would have been sold in pieces. This action could signal a desperate
c. Explain why speculators with short (sell) positions could benefit as a result of the central bank’s
intervention.
ANSWER: The central bank intervention placed downward pressure on the pound and other
European currencies. Thus, the values of futures contracts on these currencies declined. Traders that
d. Some traders with buy positions may have responded immediately to the central bank’s
intervention by selling futures contracts. Why would some speculators with buy positions leave
their positions unchanged or even increase their positions by purchasing more futures contracts in
response to the central bank’s intervention?
ANSWER: Central bank intervention sometimes has only a temporary effect on exchange rates.
25. Estimating Profits From Currency Futures and Options. One year ago, you sold a put option
on 100,000 euros with an expiration date of one year. You received a premium on the put option of
$.04 per unit. The exercise price was $1.22. Assume that one year ago, the spot rate of the euro was
$1.20, the one-year forward rate exhibited a discount of 2%, and the one-year futures price was the
same as the one-year forward rate. From one year ago to today, the euro depreciated against the
dollar by 4 percent. Today the put option will be exercised (if it is feasible for the buyer to do so).
a. Determine the total dollar amount of your profit or loss from your position in the put
b. Now assume that instead of taking a position in the put option one year ago, you sold a
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ANSWER:
a. The spot rate depreciated from $1.20 to $1.152.
b. The forward rate one year ago was equal to:
26. Impact of Information on Currency Futures and Options Prices. Myrtle Beach Co. purchases
imports that have a price of 400,000 Singapore dollars and it has to pay for the imports in 90 days. It
can purchase a 90-day forward contract on Singapore dollars at $.50 or purchase a call option contract
on Singapore dollars with an exercise price of $.50 to cover its payables. This morning, the spot rate
of the Singapore dollar was $.50. At noon, the central bank of Singapore raised interest rates, while
there was no change in interest rates in the U.S. These actions immediately increased the degree of
uncertainty surrounding the future value of the Singapore dollar over the next three months. The
Singapore dollar’s spot rate remained at $.50 throughout the day.
a. Myrtle Beach Co. is convinced that the Singapore dollar will definitely appreciate substantially
over the next 90 days. Would a call option hedge or forward hedge be more appropriate given its
opinion?
b. Assume that Myrtle Beach uses a currency options contract to hedge rather than a forward contract.
If Myrtle Beach Co. purchased a currency call option contract at the money on Singapore dollars this
afternoon, would its total U.S. dollar cash outflows be more than, less than, or the same as the total
U.S. dollar cash outflows if it had purchased a currency call option contract at the money this
morning? Explain.
ANSWER:
a. A forward hedge would be more appropriate, because it can lock in payment at $.50 per unit with
b. More, because the option premium increased due to more uncertainty
27. Currency Straddles. Reska, Inc., has constructed a long euro straddle. A call option on euros with an
exercise price of $1.10 has a premium of $.025 per unit. A euro put option has a premium of $.017 per
unit. Some possible euro values at option expiration are shown in the following table. (See Appendix
B in this chapter.)
Value of Euro at Option Expiration
$.90 $1.05 $1.50 $2.00
Call
Put
Net
a. Complete the worksheet and determine the net profit per unit to Reska Inc. for each possible
future spot rate.
b. Determine the break-even point(s) of the long straddle. What are the break-even points of a short
straddle using these options?
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ANSWER:
a.
Value of Euro at Option Expiration
$.90 $1.05 $1.50 $2.00
Call –$.025 –$.025 +$.375 +$.875
b. The break-even points for a long straddle can be found by subtracting and adding both premiums
to the exercise price. Thus, the break-even points are located at future euro spot values of $1.10 –
28. Currency Straddles. Refer to the previous question, but assume that the call and put option
premiums are $.02 per unit and $.015 per unit, respectively. (See Appendix B in this chapter.)
a. Construct a contingency graph for a long euro straddle.
b. Construct a contingency graph for a short euro straddle.
ANSWER:
a. The plotted points should create a V shape that cuts through the horizontal (break-even) axis at
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Future spot rate
$1.065 $1.135
$1.10
Future spot rate
$1.065 $1.135
$1.10
Net profit per unit
b. The plotted points should create an upside down V shape that cuts through the horizontal
(break-even) axis at $1.065 and $1.135. The peak of the upside down V shape occurs at $1.10 and
reflects a net profit of $.035.
Net profit per unit
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$.035
-$1.065
$1.065
-$.035
Future spot rate
$.526 $.574
$.55
29. Currency Option Contingency Graphs. (See Appendix B in this chapter.) The current spot rate of
the Singapore dollar (S$) is $.50. The following option information is available:
Call option premium on Singapore dollar (S$) = $.015
Put option premium on Singapore dollar (S$) = $.009
Call and put option strike price = $.55
One option contract represents S$70,000
Construct a contingency graph for a short straddle using these options.
ANSWER: The plotted points should create an upside down V shape that cuts through the horizontal
Net profit per unit
30. Speculating with Currency Straddles. Maggie Hawthorne is a currency speculator. She has noticed
recently that the euro has appreciated substantially against the U.S. dollar. The current exchange rate
of the euro is $1.15. After reading a variety of articles on the subject, she believes that the euro will
continue to fluctuate substantially in the months to come. Although most forecasters believe that the
euro will depreciate against the dollar in the near future, Maggie thinks that there is also a good
possibility of further appreciation. Currently, a call option on euros is available with an exercise price
of $1.17 and a premium of $.04. A euro put option with an exercise price of $1.17 and a premium of
$.03 is also available. (See Appendix B in this chapter.)
a. Describe how Maggie could use straddles to speculate on the euro’s value.
b. At option expiration, the value of the euro is $1.30. What is Maggie’s total profit or loss from a
long straddle position?
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$.024
-$.526
c. What is Maggie’s total profit or loss from a long straddle position if the value of the euro is $1.05
at option expiration?
d. What is Maggie’s total profit or loss from a long straddle position if the value of the euro at
option expiration is still $1.15?
e. Given your answers to the questions above, when is it advantageous for a speculator to engage in
a long straddle? When is it advantageous to engage in a short straddle?
ANSWER:
a. Since Maggie believes the euro will either appreciate or depreciate substantially, she may
b.
Per Unit Per Contract
Selling Price of € $1.30 $81,250 ($1.30 × 62,500 units)
c.
Per Unit Per Contract
Selling Price of € $1.17 $73,125 ($1.17 × 62,500 units)
– Purchase price of € –1.05 –65,625 ($1.05 × 62,500 units)
d.
Per Unit Per Contract
Selling Price of € $1.17 $73,125 ($1.17 × 62,500 units)
– Purchase price of € –1.15 –71,875 ($1.15 × 62,500 units)
e. It is advantageous for a speculator to engage in a long straddle if the underlying currency is expected
to fluctuate drastically, in either direction, prior to option expiration. This is because the advantage of
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