Practice Quiz3

Question from last year quizzes on the topics relevant to Quiz #3

1) A call option whose exercise price is less than the spot rate is said to be ____________.

(a) in-the-money(b) at-the-money(c) out-of-the-money(d) around-the-money

2) When the current spot exchange rate exceeds the exercise price which of the following combinations of statements is true?

(i) A call option is in the money(ii) A call option is out of the money(iii) A put option is in the money(iv) A put option is out of the money

a) (i) and (ii)b) (i) and (iii)c) (i) and (iv)d) (ii) and (iv)

3) The value of a European call option will increase with all of the following except:a) the spot exchange rateb) the exercise pricec) time to maturityd) the domestic interest rate

4) Operating exposure can be defined as:a) the future home currency values of the firm’s assets and liabilitiesb) the extent to which the firm’s operating cash flows would be affected by random

changes in exchange ratesc) the sensitivity of realized domestic currency values of the firm’s contractual cash

flows denominated in foreign currencies to unexpected exchange rate changesd) the potential that the firm’s consolidated financial statement can be affected by

changes in exchange rates

5) The exposure coefficient, b, in the asset exposure regression model is defined asa) Cov (P, S) / Cov (S)b) Cov (P, S) / Var (S)c) Var (S) / Cov (P,S)d) Cov (P, S) / Var (P)

6) Use the following information to calculate the quality spread differential (QSD):

Fixed-Rate Floating-Rate Borrowing Cost Borrowing Cost

X Company: 10% LIBOR

Y Company: 12% LIBOR + 1.5

a) 0.50%b) 1.00%c) 1.50%d) 2.00%

7) Firm A needs to borrow £1M for 20 years. It can borrow £s at 7% or it can borrow $s at 9%Firm B needs to borrow $2M for 20 years. It can borrow £s at 8% or it can borrow $s at 11.2%The spot exchange rate is 2$/£. Firms would like to engage in a swap using a help of the swap bank so that QSD is equally divided among all three parties and neither firm will be exposed to the exchange rate risk What is the annual GROSS interest payment of firm A to the swap bank? (where “GROSS” means that it does not take into account the payment made by the swap bank to firm A on the loan that firm A made to the swap bank)

a) £70,000b) £80,000c) $180,000d) $224,000e) £66,000f) £76,000g) $72,000h) $216,000

8 Assume that 1-year American put option has an exercise price of $1.50/£. At a current spot exchange rate of $1.46/£ the holder of the option finds decides that it is optimal not to exercise it right now. Hence, this option has

(a) a time value of $0.04.(b) a time value of $0.00.(c) a market value of $0.00.(d) a market value of $0.04.(e) None of the above

9) Assume that 1-year European put option with exercise price of $1.4/£ is selling for $0.10. If current spot exchange rate is $1.46/£, what is the time value of this option?

(a) $0.00(b) $0.04(c) $0.06(d) $0.10(e) Cannot be determined from the available information

10) What is the price of a 1-year European call option for £1 with a strike price of 2.5$/£ if the current spot exchange rate is 2.2$/£, next year exchange rate can be either 2.42$/£ or 2$/£, the dollar interest rate is 5%, and the pound interest rate is 9%

a) under $0.01b) between $0.01 and $0.02c) between $0.02 and $0.03d) between $0.03 and $0.04e) between $0.04 and $0.05f) between $0.05 and $0.06g) above $0.06

11) What is the price of 1-year European call option for £1 with a strike price of 2.1$/£ if the current spot exchange rate is 2.15$/£, next year exchange rate can be either 2.25$/£ or 2.05$/£, the dollar interest rate is 7% and the pound interest rate is 4%


12) What is the price of 1-year European put option for £1 with a strike price of 2.1$/£ if the current spot exchange rate is 2.15$/£, next year exchange rate can be either 2.25$/£ or 2.05$/£, the dollar interest rate is 7% and the pound interest rate is 4%


13) What is the next year forward rate if 1-year European call option for £1 with a strike price of 1.9 $/£ is selling for $0.30, 1-year European put option for £1 with a strike price of 1.9 $/£ is selling for $0.10, the dollar interest rate is 7% and the pound interest rate is 4%Hint: Consider a portfolio that consists of long call, short put, and short forward. Look at its value today next year. Use this information to answer the question and do not forget about the time value of money.

a) less or equal to 1.6 $/£b) greater than 1.6 $/£ but less than 1.7 $/£ c) exactly equal to 1.7 $/£c) greater than 1.7 $/£ but less than 1.9 $/£d) exactly equal to 1.9 $/£e) greater than 1.9 $/£ but less than 2.1 $/£f) exactly equal to 2.1 $/£g) greater than 2.1 $/£ but less than 2.2 $/£h) greater or equal to 2.2 $/£

Solutions:

1) Answer: A2) Answer: c 3) Answer: b 4) Answer: b 5) Answer: b 6) Answer: a Solution: (LIBOR+12%)-(LIBOR+1.5%+10%)

7) Answer: ESolution: QSD=1.2%. Thus, firm A borrows £1M from Swap Bank at 7-1.2/3=6.6% (it also borrows $ at 7% from outside and pass them through to the Swap Bank at the same7%)

8) Answer: ESolution: If it is optimal not to exercise, then time value >0 and the market value = intrinsic + time value >$0.04+0.

9) Answer: DSolution: Time value = price minus intrinsic value = 0.1-0=$0.1

10) Answer: ASolution: The option will always be out of the money, so, its value is zero.

11) Answer: FSolution: S0 S1 C Profit

2.25 0.15 0.2

2.15

2.05 0 0Buy 1/1.04=0.9615£, borrow 2.05/1.07=$1.9159 payoff (above) price of the portfolio is Pport= 0.96152.15-1.9159 = $0.1513 C0=0.1513*0.15/0.2=$0.1134

12) Answer: ASolutionS0 S1 P Profit

2.25 0 0

2.15

2.05 0.05 -0.2Buy 1/1.04=0.9615£, borrow 2.25/1.07=$2.1028 payoff (above) Price of the put is Pput = -(0.05/0.2)*( 0.96152.15-2.1028) = $0.0088

13) Answer: GSolution: Portfolio=long call + short put +short forward. Its value today (how much you need to pay to buy it) is equal to 0.3-0.1-0=$0.2/ Next year long call + short put is equivalent to the agreement to buy 1£ at 1.9 $/£ while short forward is equivalent to the agreement to sell 1£ at 1.9 $/£ at forward rate F. Thus, next year this portfolio has a certain value of $(F-1.9). So, this is a risk-free portfolio. Therefore, its value today must be equal to the PV of its value next year, i.e., 0.2=(F-1.9)/1.07. Hence, F=0.2*1.07+1.9=2.114$/£

Documents

Practice Quiz3