Question

Strike Price		Maturity		Premium
$1.36/£		30 days		$0.00081/£
$1.34/£		30 days		$0.00021/£
$1.32/£		30 days		$0.00004/£
$1.36/£		60 days		$0.00333/£
$1.34/£		60 days		$0.00150/£
$1.32/£		60 days		$0.00060/£

Doyle Holmes is a currency trader for Watson Investments, a private investment house in London. Watson’s clients are a collection of wealthy private investors who, with a minimum stake of £250,000 each, wish to speculate on the movement of currencies. The investors expect annual returns in excess of 25%. Although offices are in London, all accounts and expectations are based in U.S. dollars. Doyle is convinced that the British pound will slide significantly. To an expected spot price of $1.3455/£ -- in 30 days and possibly as low as $1.3185/£ -- in 60 days. The current spot rate is $1.4260/£. If the 30-day forward rate is $1.3858/£ should he enter a position, why or why not? Now, Doyle wishes to buy puts on pounds, which will yield the 25% return expected by his investors. Which of the following put options would you recommend he purchase. Prove your choice is the preferable combination of strike price, maturity, and up-front premium expense (show the return on the investment of £250,000).

Answer 1

	Current spot rate	$1.4260	per Pound
	Forward Rate-30days	$1.3858	per Pound
	He can buy dollar at spot rate
	And sell dollar to buy Pound at forward rate
	Amount of dollars bought=250000*1.4260	$356,500
	Amount of Pound received after 30 days	£          257,252.13	(356500/1.3858)
	Profit Percent in 30 days=(257252.13/250000)-1	2.90%
	Annualized Profit	34.81%
	He can enter into the position.It gives him required return
	BUYING PUT	A	B	C	D	E=A-D	F=(E/C)-1
		Strike Price	Maturity	Premium	Expected	Expected	Return on
		Per Pound	in days	Per Pound	spot price	Gain per Pound	Investment
		$1.36	30	$0.00081	$1.3455	$0.0145	16.9012346
		$1.34	30	$0.00021	$1.3455	$0.0000	-1
		$1.32	30	$0.00004	$1.3455	$0.0000	-1
		$1.36	60	$0.00333	$1.3185	$0.0415	11.4624625
		$1.34	60	$0.00150	$1.3185	$0.0215	13.3333333
		$1.32	60	$0.00060	$1.3185	$0.0015	1.5
	RECOMMENED ACTION
	BUY PUT : Strike Price $1.36, Maturity 30 days
	Premium per pound	$0.00081
	Convert 250000 pound to dollar at current spot rate
	Amount of Dollars =250000*1.4260=	$          356,500.00
	Number of Puts bought =356500/0.00081	440,153,456		440153456
	Expected gain=440123456*0.0145=	$6,382,225
	Amount available after 30 days	$6,382,225
	Spot rate after 30 days	$1.3455	per Pound
	Amount of Pounds at spot rate=6382225/1.3455	£             4,743,385
	Amount of return =4743385-250000=	£             4,493,385