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Nareewat Kujareevanich 5302640635 Advanced Problem 32.

a) In order to construct a put bull spread, the spreader has to buy a put option at lower exercise price ($1.60)and write a put option with a higher exercise price($1.62). For call option, the premium for the written option is lower. Therefore it would generate cash outflow and result in debit spread. However, for put option, the premium for the written option is higher. Therefore it would generate cash inflow and result in credit spread. b) Value of British Pound at $1.55 (1.60-1.55)-0.03=0.02 (1.55-1.62)+0.04=-0.03 -0.01 Option Expiration $1.60 (1.60-1.60)-0.03=-0.03 (1.60-1.62)+0.04=0.02 -0.01 $1.62 -0.03 0.04 0.01 $1.67 -0.03 0.04 0.01

Put @ $1.60 Put @ $1.62 Net

c) Net=(-0.03)+(0.04)=$-0.01 (loss) d) at rate= $1.58 Net= -1.60-0.04+1.62+0.03=$ 0.01 33) Long Currency Straddle Maximum loss at strike price (1.17$) =total premium= 0.02+0.015=0.035 Upper BE= x-total premium =1.17+(0.035)=$1.205 Lower BE=x-total premium=1.17-(0.035)=$1.135

Long Currency Straddle


0.04 0.03 0.02 0.01 0.00 -0.01 -0.02 -0.03 -0.04 -0.035 1.1000 1.1350 1.1700 1.2050 1.2400

Short Currency Straddle Maximum gain at strike price (1.17$) =total premium= 0.02+0.015=0.035 Upper BE= x-total premium =1.17+(0.035)=$1.205 Lower BE=x-total premium=1.17-(0.035)=$1.135

Short Currency Straddle


0.04 0.03 0.02 0.01 0 -0.01 -0.02 -0.03 -0.04 1.1000 1.1350 1.1700 1.2050 1.2400 0.035

34) a)

Call @ $1.56 Call @ $1.59 Net

$1.50 1.50-1.50-0.08=-0.08 1.50-1.50+0.06=0.06 -0.02

Value Of Euro $1.56 1.56-1.56-0.08=-0.08 1.56-1.56+0.06=0.06 -0.02

At Option Expiration $1.59 1.59-1.56-0.08=-0.05 1.59-1.59+0.06=0.06 0.01

$1.65 1.65-1.56-0.08=0.01 1.59-1.65+0.06=0.00 0.01

b) X-1.56-0.08+(x-x+0.06)=0 x=1.58 c)maximum profit=0.01 maximum loss=0.02 d) Net= 1.58-1.56-0.08+(1.58-1.58+0.06)= 0 e) Net=0.08-(0.06)=0.02 35) a)

Call Put Net

$0.90 0.90-0.90-0.025=-0.025 1.10-0.90-0.017=0.183 0.158 b) Long straddle

Value Of Euro At Option Expiration $1.05 $1.50 1.05-1.05-0.025=-0.025 1.50-1.10-0.025=0.3750 1.10-1.05-0.017=0.033 1.50-1.50-0.017=-0.017 0.008 0.358

$2.00 2.00-1.10-0.025=0.875 2.00-2.00-0.017=-0.017 0.858

when spot rate (x) is less than exercise price(1.10) : x-x-0.025+(1.10-x-0.017)=0 x=1.058 when spot rate (x) is more than exercise price(1.10) : x-1.10-0.025+(x-x-0.017)=0 x=1.142 Short Straddle when spot rate (x) is less than exercise price(1.10): x-x+0.025+(x-1.10+0.017)=0 x=1.058 when spot rate (x) is more than exercise price(1.10) : 1.10-x+0.025+(x-x+0.017)=0 x=1.142 36) a)Since it expects that there would be a widely fluctuation of JPY against USD, he should construct a long currency strangle by long the put and call option. The call option will have the higher exercise price. Barry would pay less in order to construct this condition. Also, it could gain profit from the fluctuation of JPY. b) when x (spot rate) is less then 0.0084 -0.0007+(0.0084-x-0.0005)=0 X=0.0072 When x (spot rate) is more than 0.0085 (x-0.0085-0.0007)+(-0.0005)=0 X=0.0097 c) -0.0007+(0.0084-0.007-0.0005)=0.0002 profit

The total profit=0.0002x6250000=$1250 d) 0.009-0.0085-0.007+(-0.005)=-0.0007 loss The total loss=0.0007x6250000=$4735

Integrative Problem 1) For UK., when inflation rate is expected to decline, people are going to think that the interest rate would decline too because nominal interest rate= real interest rate+ inflation rate. Then capital flow from foreign portfolio investment will decrease. However for the foreign direct investment, capital will not flow in as much as capital flow out from FPI because FDI is less interest elastic. Thus, the international trade flow will decrease. For US., when inflation rate is expected to rise, people are going to think that the interest rate would rise up too because nominal interest rate= real interest rate+ inflation rate. Then capital flow from foreign portfolio investment will increase while the capital from foreign direct investment will not flow out as much as capital flow out from FPI because FDI is less interest elastic. Thus, the international trade flow will increase. However, since there is an expected inflation in US. People could expect that the price of US goods will rise. Then it could result in reducing in consumption in US goods which mean that there will be less export and reduce the cash inflow from trade. 2) Since there is a less consumption on US good, people would need less USD and result in demand curve of USD shift to the left. Still, capital inflow in US is increasing and that make the demand curve shift to the right. According to the fact that the international capital flows has larger effect than cash flow form exported good, the final demand curve will shift to the right. This result in the appreciation if USD against Pound. Pound value would decline 3) Interest rate Parity is the condition that investor would not gain from investing aboard which has higher interest rate comparing to their home town. The interest rate and the exchange rate will adjust to the point such that the arbitrage is no longer feasible. 4) Yes. Since the British pound will depreciate, when Mesa convert pound back to USD, Mesa will get less USD comparing to USD amount will be got when BP is not depreciate. 5) Yes, Mesa should hedge the exchange rate risk. It could forward contract to sell pound at specified satisfied price. Also, it could use currency futures contract to sell pound. Moreover, put option could be used to lock the price that Mesa could exchange Pound for USD.