3. (a) Define currency options contract. What are put and call options? (b) You bought a...

3. (a) Define currency options contract. What are put and call options? (b) You bought a Dec. 20 call option on Australian dollar with a strike price (K) of $0.7850/A$ in June 20 and paid a premium of $0.02/A$. The current spot exchange (S) rate for A$ is $0.7920/A$. (i) What are the intrinsic and the time values of this option? (ii) (a)What is the profit/loss if the option is exercised at expiration if the spot rate settles at $0.8000/A$? (b) if the spot rate settles at $0.7800? The U.S. interest rate is 2%.

Expert Solution

(a) Define currency options contract. What are put and call options?

The currency options contracts are rights but not the obligation to exchange (buy or sell) one currency into another at a pre-determined exchange rate at a pre-determined timeline.

A call option gives the holder right but not the obligation to buy one currency using another, at a pre-determined exchange rate at a pre-determined timeline.

A put option gives the holder right but not the obligation to sell one currency for another, at a pre-determined exchange rate at a pre-determined timeline.

(b) You bought a Dec. 20 call option on Australian dollar with a strike price (K) of $0.7850/A$ in June 20 and paid a premium of $0.02/A$. The current spot exchange (S) rate for A$ is $0.7920/A$. (i) What are the intrinsic and the time values of this option? (ii) (a)What is the profit/loss if the option is exercised at expiration if the spot rate settles at $0.8000/A$? (b) if the spot rate settles at $0.7800? The U.S. interest rate is 2%.

(i) Intrinsic value of the option = S - K = $0.7920/A$ - $0.7850/A$ = $ 0.0070 / A$

Time value of the option = C - intrinsic value = 0.02 - 0.0070 = $ 0.0130 / A$

(ii) (a) Profit / (Loss) = max (S - K, 0) - C = max (0.8 - 0.7850, 0) - 0.02 = - $ 0.0050 / A$

(b) Profit / (Loss) = max (S - K, 0) - C = max (0.7800 - 0.7850, 0) - 0.02 = - $ 0.02 / A$

jeff jeffy answered 2 years ago

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