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Assignment 1

This document contains 5 questions related to financial derivatives: Q1 asks about the profit from a long forward contract and long put option on the same asset with the same maturity date and strike price equal to the forward price. Q2 describes an index currency option note from the 1980s that pays the holder different amounts depending on a currency exchange rate, and asks how it can be represented as a combination of regular bonds and options. Q3 describes a strategy of entering offsetting forward contracts on the same currency and asks about the payout. Q4 asks about arbitrage opportunities from currency options given spot and forward exchange rates. Q5 asks about the upfront cost, gains, and losses

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Aniket Verma
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24 views

Assignment 1

This document contains 5 questions related to financial derivatives: Q1 asks about the profit from a long forward contract and long put option on the same asset with the same maturity date and strike price equal to the forward price. Q2 describes an index currency option note from the 1980s that pays the holder different amounts depending on a currency exchange rate, and asks how it can be represented as a combination of regular bonds and options. Q3 describes a strategy of entering offsetting forward contracts on the same currency and asks about the payout. Q4 asks about arbitrage opportunities from currency options given spot and forward exchange rates. Q5 asks about the upfront cost, gains, and losses

Uploaded by

Aniket Verma
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Assignment 1

Q1. Describe the prot from the following portfolio: a long forward contract on an asset and
a long European put option on the asset with the same maturity as the forward contract
and a strike price that is equal to the forward price of the asset at the time the portfolio
is set up.

Q2. In the 1980s, Bankers Trust developed index currency option notes (ICONs). These are
bonds in which the amount received by the holder at maturity varies with a foreign ex-
change rate. One example was its trade with the Long Term Credit Bank of Japan. The
ICON specied that if the yenU.S. dollar exchange rate, ST , is greater than 169 yen per
dollar at maturity (in 1995), the holder of the bond receives $1,000. If it is less than 169
yen per dollar, the amount received by the holder of the bond is

When the exchange rate is below 84.5, nothing is received by the holder at maturity. Show
that this ICON is a combination of a regular bond and two options.

Q3. On July 1, 2011, a company enters into a forward contract to buy 10 million Japanese yen
on January 1, 2012. On September 1, 2011, it enters into a forward contract to sell 10
million Japanese yen on January 1, 2012. Describe the payo from this strategy.

Q4. Suppose that USD-sterling spot and forward exchange rates are as follows:

Spot 1.5580
90-day forward 1.5556
180-day forward 1.5518

What opportunities are open to an arbitrageur in the following situations?

(a) A 180-day European call option to buy ¿1 for $1.52 costs 2 cents.

(b) A 90-day European put option to sell ¿1 for $1.59 costs 2 cents.

Q5. On May 8, 2013, the spot oer price of Google stock is $871.37 and the oer price of a call
option with a strike price of $880 and a maturity date of September is $41.60.

A trader is considering two alternatives: buy 100 shares of the stock and buy 100 September
call options.

For each alternative, what is

(a) the upfront cost,


(b) the total gain if the stock price in September is $950, and
(c) the total loss if the stock price in September is $800.

1
Assume that the option is not exercised before September and if stock is purchased it is
sold in September.

Table 1.2 Prices of call options on Google, May 8, 2013, from


quotes provided by CBOE; stock price: bid $871.23, oer $871.37.
Strike price June 2013 September 2013 December 2013
($) Bid Oer Bid Oer Bid Oer
820 56.00 57.50 76.00 77.80 88.00 90.30
840 39.50 40.70 62.90 63.90 75.70 78.00
860 25.70 26.50 51.20 52.30 65.10 66.40
880 15.00 15.60 41.00 41.60 55.00 56.30
900 7.90 8.40 32.10 32.80 45.90 47.20
920 n.a. n.a. 24.80 25.60 37.90 39.40

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