Impact of Information on Currency Option Premiums As of 10: 00 a.m . the premium on a specific one-year call option on British pounds is S0.04. Assume that the Bank of England had not been intervening in the foreign exchange markets in the last several months. However, it announces at 10: 01 a.m. that it will begin to frequently intervene in the foreign exchange market so as to reduce fluctuations in the pound’s value against the U.S. dollar over the next year, but it will not attempt to push the pound’s value higher or lower than what is dictated by market forces. Also, the Bank of England has no plans to affect economic conditions with this intervention. Most participants who trade currency options did not anticipate this announcement. When they heard the announcement, they expected that the intervention would be successful in achieving its goal. Will this announcement cause the premium on the one-year call option on British pounds to increase, decrease, or be unaffected? Explain.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 6, Problem 21QA
Textbook Problem

Impact of Information on Currency Option Premiums As of 10: 00 a.m . the premium on a specific one-year call option on British pounds is S0.04. Assume that the Bank of England had not been intervening in the foreign exchange markets in the last several months. However, it announces at 10: 01 a.m. that it will begin to frequently intervene in the foreign exchange market so as to reduce fluctuations in the pound’s value against the U.S. dollar over the next year, but it will not attempt to push the pound’s value higher or lower than what is dictated by market forces. Also, the Bank of England has no plans to affect economic conditions with this intervention. Most participants who trade currency options did not anticipate this announcement. When they heard the announcement, they expected that the intervention would be successful in achieving its goal. Will this announcement cause the premium on the one-year call option on British pounds to increase, decrease, or be unaffected? Explain.

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