Fundamentals of Multinational Finance, 3e (Moffett)




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Topic:



^ Currency Options Pricing

Skill:



Recognition

44)



The ________ of an option is the value if the option were to be exercised immediately. It is the options ________ value.

A)



intrinsic value; maximum

B)



intrinsic value; minimum

C)



time value; maximum

D)



time value; minimum

Answer:



B

Topic:



Currency Options Intrinsic Value

Skill:



Recognition

45)



Assume that a call option has an exercise price of $1.50/³. At a spot price of $1.45/³, 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

Answer:



C

Topic:



Currency Options Intrinsic Value

Skill:



Analytical

46)



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.)

Answer:



FALSE

Topic:



Currency Options Time Value

Skill:



Conceptual

47)



Other things equal, the price of an option goes up as the volatility of the option decreases.

Answer:



FALSE

Topic:



Currency Options Volatility

Skill:



Conceptual

48)



Volatility cannot be directly observed for calculation purposes of the option pricing model. Therefore, it may be determined from

A)



historic volatility.

B)



forward-looking volatility.

C)



implied volatility.

D)



any of the above.

Answer:



D

Topic:



Currency Options Volatility

Skill:



Recognition

49)



Volatilities are the only judgmental aspect of currency option pricing and are therefore, the least important component therein.

Answer:



FALSE

Topic:



Currency Options Volatility

Skill:



Conceptual

50)



________ volatility are calculated by being backed out of the market option premium values traded.

A)



Historic

B)



Forward-looking

C)



Implied

D)



None of the above

Answer:



C

Topic:



Currency Options Volatility

Skill:



Recognition

51)



Dash Brevenshure works for the currency trading unit of ING Bank in London. He speculates that in the coming months the dollar will rise sharply vs. the pound. What should Dash do to act on his speculation?

A)



Buy a call on the pound.

B)



Sell a call on the pound.

C)



Buy a put on the pound.

D)



Sell a put on the pound.

Answer:



C

Topic:



Options Market

Skill:



Conceptual

52)



A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes your profit if you choose to exercise the option before maturity?

A)



¥100/$

B)



¥105/$

C)



¥110/$

D)



¥115/$

Answer:



D

Topic:



Options Market

Skill:



Conceptual

53)



A call option on euros is written with a strike price of $1.30/euro. Which spot price maximizes your profit if you choose to exercise the option before maturity?

A)



$1.20/euro

B)



$1.25/euro

C)



$1.30/euro

D)



$1.35/euro

Answer:



D

Topic:



Options Market

Skill:



Conceptual


54)



A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?

A)



$2.03/£

B)



$2.07/£

C)



$2.05/£

D)



The answer depends upon if this is a long or a short call option.

Answer:



B

Topic:



Call Option

Skill:



Analytical

55)



Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should

A)



buy a pound put option.

B)



sell a pound put option.

C)



buy a pound call option.

D)



sell a pound call option.

Answer:



C

Topic:



Call Option

Skill:



Conceptual

8.2



Essay Questions

1)



Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

Answer:



Foreign currency futures are standardized contracts that lend themselves well to speculation purposes but less so for hedging purposes. The standardized nature of the futures contract makes it easy to trade futures and to make bets about general changes in the value of currencies. Forward contracts are better for hedging in that they are tailored to meet the specific needs of the client, typically a business, and can be quite useful in reducing exchange rate risk. Banks are involved in the foreign currency futures market in part to offset positions that they may have taken in the forward markets as dealers.

2)



Compare and contrast foreign currency options and futures. Identify situations when you may prefer one vs. the other when speculating on foreign exchange.

Answer:



Foreign currency futures are derivative securities that allow the holder to lock in a price today for another currency at some point in the future. The foreign currency future contract is an obligation on the part of the parties to fulfill the terms of the contract. Even if prices change in an unanticipated way, the parties are obligated to fulfill the terms of the contract. The foreign currency option contract on the other hand is a right not an obligation to purchase/sell a currency at some point in the future at a price agreed upon today. If prices change in an unexpected manner, the buyer of the contract is under no obligation to exercise the contract. Option contracts are better suited to situations where price changes are anticipated, but the direction of the change is highly uncertain.

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