International Financial Management
14th Edition
ISBN: 9780357130698
Author: Madura
Publisher: Cengage
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Consider a one period binomial model of a currency option on the dollar. Thecurrent (date t = 0) spot exchange rate is S0 = 75 pence per dollar. The spot rateat the end of the period will be either Su = 100 pence or Sd = 60 pence. The UKrisk-free interest rate over the period is rs = 1/3 (33.3333%) and the US risk-freerate of interest is rd = 1/4 (25%). There is a call option with a strike price ofK = 68 pence and a forward contract with a price of F = 80 pence. Show how touse the forward contract and the UK money market to replicate the payoffs to thecall option and hence, find the price of the call option.
Consider a 1-year semi-annually paid interest rate swap, the notional is £1,000,000, the swap rate is 3.0%, the floating rate is GM LIBOR + 1%. On the market, the 6M LIBOR spot and its 6-month maturity forward are 3.0% and 1.0%, respectively. Sketch the cash-flow diagram of the fixed-leg.
Question 1
Consider the option on currency HKD against the USD:
Current spot rate is HKD7.50 for 1 USD:· Risk-free HKD rate of interest is 5% p.a.· Risk-free USD rate of interest is 2% p.a.· Volatility (σ) of the currency returns is 20% p.a.· Maturity of the option is 3 months.· Strike rate of the option is HKD8.00 for 1 USD· The currency options are European in nature
(a) Draw the terminal payoff diagram for the holder of the currency call option on HKD.
(b) Draw the terminal payoff diagram for the holder of the currency put option on USD.
(c) How much does it cost to hold (i.e., buy) a call-HKD option? Use the Garman Kohlhagen model.
(d) What is the minimum terminal exchange rate for the holder of the call-HKD option to profit fromholding the currency option?…
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- Required:a. Calculate the dollar proceeds from the FI’s loan portfolio at the end of the year, the return on the FI’s loan portfolio, and the net return for the FI if the pound spot foreign exchange rate falls to $1.20/£1 and the lira spot foreign exchange rate falls to $0.156/TL1 over the year.b. Calculate the dollar proceeds from the FI’s loan portfolio at the end of the year, the return on the FI’s loan portfolio, and the net return for the FI if the pound spot foreign exchange rate rises to $1.40/£1 and the lira spot foreign exchange rate rises to $0.17/TL1 over the year.c. Suppose that the FI funds the $250 million U.S. loans with $250 million one-year U.S. CD at a rate of 4 percent; funds $150 equivalent British loans with $150 million equivalent one-year pound CDs at a rate of 5 percent; funds $100 million equivalent Turkish loans with $100 million equivalent one-year Turkish lira CDs at a rate of 6 percent. Assume no other changes. What will the FI’s balance sheet look like…arrow_forwardConsider a one-period binomial model in which the underlying is at 65 Euros, and can go up 30% or down 22% each period. The risk-free rate is 8%. Determine the price of a European put option with exercise price of 70. Assume that the put is selling for 9 Euros. Demonstrate how to execute an arbitrage transaction and calculate the rate of return. Use 10000 puts.arrow_forwardAssume that interest rate parity holds and that 90-day risk-freesecurities yield a nominal annual rate of 3% in the United States and a nominal annual rateof 3.5% in the United Kingdom. In the spot market, 1 pound = $1.29.a. What is the 90-day forward rate?b. Is the 90-day forward rate trading at a premium or a discount relative to the spot rate?arrow_forward
- Consider a one-period binomial model in which the underlying is at 65 Euros, and can go up 30% or down 22% each period. The risk-free rate is 8%. European Put Option with Execution Price of 70 Euros. Assume that the put is selling for 9 Euros. Demonstrate how to execute an arbitrage transaction and calculate the rate of return. Use 10000 puts.arrow_forwardYou observe the following quotes for the USD/AUD in the spot market from two banks:Bank of Sydney /Bank of New YorkBid Ask/ Bid Ask0.71711 0.71715 /0.71708 0.71715Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculatethe potential profit if you are able to use AUD 25,000. If not, explain why arbitrage is not possible?(b) You observe the following quotes for the GBP /AUD in the spot market from two banks:Bank of Melbourne/ Bank of LondonBid Ask/ Bid Ask0.5458 0.5459 /0.5514 0.5515Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculatethe potential profit if you are able to use GBP 50,000. If not, explain why arbitrage is not possible?c) You observe the following quotes for the EUR / USD in the spot market from two banks:Deutsche Bank/ Bank of AmericaBid Ask /Bid Ask1.18102 1.18102 /1.18094 1.18100Do these quotes imply the possibility of earning a profit by using locational arbitrage? If…arrow_forwardSuppose a US investor purchases a UK equity. Let the expected pound return on the U.K. equity be 20%, and let its volatility (measured by standard deviation) be 30%. The volatility of the dollar/pound exchange rate is 10%. The risk-free rate in the U.S. (denoted rf) is 2%. Compute the volatility of the dollar return on the U.K. equity when the correlation (denoted as r) between the U.K. equity's return in pounds and changes in the dollar/pound exchange rate is 0.5.arrow_forward
- If the euro is selling at a discount relative to the USD in the forward market, is the forward price of USD/EUR larger or smaller than the spot price of the USD/EUR? Group of answer choices a Larger b Smaller c Indeterminate d The samearrow_forwardA financial institution owns a portfolio of options dependent on the US Dollar Sterling exchange rate. The delta of the portfolio with respect to percentage changes in the exchange rate is 7.3. If the daily volatility of the exchange rate is 0.5% and a linear model is assumed, calculate the estimated 10-day 95% VaR for the portfolio.arrow_forwardThe current exchange rate from dollars to British pounds is 1.03 ($/pound). The current dollar denominated continuously compounded risk-free rate 4% and you observe the current pound forward contract with 3 years to maturity to have a forward price of $1.11 .a. What is the implied pound denominated risk-free rate? b. If the actual pound denominated risk-free rate is 0%, how would you create an arbitrage opportunity? c. What is the arbitrage profit from your strategy in part b?arrow_forward
- a) Assume that call currency option enable to buy of dollar for Shs. 50.00 while it is quotedat Shs. 50.70 in the spot market, and premium paid for call currency option is Shs. 1.00.a)Calculate the intrinsic value of the call? b) Discuss the value of hedging to a firm.arrow_forwarda) You observe the following quotes for the USD/AUD in the spot market from two banks: Bank of Sydney Bank of New York Bid Ask Bid Ask 0.71711 0.71715 0.71708 0.71715 Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculate the potential profit if you are able to use AUD 25,000. If not, explain why arbitrage is not possible? (b) You observe the following quotes for the GBP /AUD in the spot market from two banks: Bank of Melbourne Bank of London Bid Ask Bid Ask 0.5458 0.5459 0.5514 0.5515 Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculate the potential profit if you are able to use GBP 50,000. If not, explain why arbitrage is not possible? c) You observe the following quotes for the EUR / USD in the spot market from two banks: Deutsche Bank Bank of America Bid Ask Bid Ask 1.18102 1.18102 1.18094 1.18100 Do these quotes imply the…arrow_forward
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