1. Using the following table, consider an American style call option on the euro. The
current euro spot exchange rate is $0.9657, and each option contract is for E62,500.
Vol. Last Vol. Last
960 Jun ... ... 5 0.0161
980 Jun 14 0.0188 ... ...
1000 Jun 1 0.0117 ... ...
1020 Jun 1 0.0600 ... 0.0100
a. Is the 980 call option currently in the money, at the money, or out of the
b. Suppose that your corporate economist believes the euro may appreciate
against the dollar to an exchange value as high as $1.02 or depreciate to an
exchange value as low as $0.96. She therefore purchases eight call contracts to
partially hedge an underlying short exposure of 750,000 euros. Draw a diagram
illustrating the potential loss or gain on all eight contracts.
c. Indicate the amount of loss or profit at $0.96, $1.02 and the current spot rate.
(Keep all calculations to two decimal places).
d. Indicate the break-even rate.
e. Add to your diagram a line indicating the gain and loss on the underlying
exposure as the spot deviates from the current level. Indicate the gain or loss at
$0.96 and $1.02.
2. Suppose your company owes a 1,500,000 Australian dollar (A$) payment due in
March. If the A$ were to appreciate against the dollar, the dollar value of this future
payment will increase and your company will experience a loss. Because of this foreign
exchange risk exposure, you decide to use a futures contract as a hedge.
a. Explain how you would use A$ futures: number of contracts, long or short- and
how the futures account would act as a hedge.
b. Suppose you undertake this transaction with December A$ futures on the first
of March at the moment the market opens. Show how your initial margin changes
daily (for the first through the fourth days). Indicate any cash flows generated or
Open High Low Settle Change Interest
AUSTRALIAN DOLLAR (CME) – 100,000A$; $ per A$
1st March .5251 .5267 .5213 .5252 -.0046 2,007
2nd March .5216 .5216 .5110 .5127 -.0125 2,180
3trd March .5108 .5120 .5029 .5115 -.0012 3,037
4th March .5085 .5112 .5058 .5086 -.0029 3,363
Agreement Maintenance Initial
$ 100,000 $ 1,100 $ 1,485
Change in account CF Account end of day
1 $ $ $
2nd $ $ $
3rd $ $ $
4th $ $ $
c. How would you close out your position at the end of the fourth day?