Question

In: Finance

1 A) The 90-day forward rate for the euro is $1.08, while the current spot rate...

1 A) The 90-day forward rate for the euro is $1.08, while the current spot rate of the euro is $1.05. What is the annualized forward premium or discount of the euro?

11.4% discount

11.4% Premium

7.6% premium

7.6% discount

1 B) Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.58 by the expiration date. The highest net profit possible for the speculator based on the information above is:

$1,562.50.


–$1,562.50.


–$937.50


–$625.00.

Solutions

Expert Solution

Part 1:
Correct answer is 11.4% premium
Annualized forward premium or discount is given by:
[Forward rate/Spot rate-1]*360/90
Given that forward rate for the euro=$1.08
Current spot rate of the euro is $1.05
Annualized forward premium or discount of the euro=[$1.08/$1.05-1]*360/90
=[1.028571429-1]*360/90
=0.028571429*360/90
=0.114285716 or 11.4% (this value is positive so it is premium)

Part 2:
Correct answer is -$1,562.50.
The premium of the option is calculated as:
Amount per unit*number of units purchased
Given that the speculator purchased a put option on British pounds for $.05 per unit. The speculator purchased 31,250 units.
The premium of the option=$.05*31,250=$1562.5
Given that strike price of the put option is $1.50.
As it is a put option, its value will increase if the price falls below the strike price. As the price has continuously risen to $1.58 by the expiration date, the option will not be exercised by the speculator. Hence, the net profit is -$1,562.50.


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