Deck 7: Foreign Currency Derivatives: Futures and Options

Question 1

Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?

A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain

Answer 1

$937.50 loss

Question 2

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. Jasper should ________ at ________ to profit from changing currency values.

A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.

Answer 2

buy yen; the forward rate

Question 3

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today's spot price and sells within the next six months at ¥128/$, he will earn a profit of:

A) $146.09.
B) $101,460.94.
C) $1460.94.
D) nothing; he will lose money

Answer 3

$1460.94.

Question 4

A speculator in the futures market wishing to lock in a price at which they could ________ a foreign currency will ________ a futures contract.

A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above

Question 5

Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a:

A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.

Question 6

A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.

A) futures
B) forward
C) option
D) swap

Question 7

A speculator that has ________ a futures contract has taken a ________ position.

A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold

Question 8

Financial derivatives are powerful tools that can be used by management for purposes of:

A) speculation.
B) hedging.
C) human resource management.
D) A and B above

Question 9

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and selling a forward contract than if he had invested her money in 6-month U.S. Treasury securities at an annual rate of 2.50%.

Question 10

Which of the following statements regarding currency futures contracts and forward contracts is NOT true?

A) A futures contract is a standardized amount per currency whereas the forward contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between individuals and banks with other banks via telecom linkages.
D) All of the above are true.

Question 11

A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given amount of foreign exchange at a fixed price per unit for a specified period.

A) future
B) forward
C) option
D) swap

Question 12

About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.

A) 0%
B) 5%
C) 50%
D) 95%

Question 13

Which of the following is NOT a contract specification for currency futures trading on an organized exchange?

A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.

Question 14

Currency futures contracts have become standard fare and trade readily in the world money centers.

Question 15

Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

Question 16

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper's expectations are correct, then he could profit in the forward market by ________ and then ________.

A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question.
D) He could not profit in the forward market.

Question 17

Which of the following is NOT a difference between a currency futures contract and a forward contract?

A) The futures contract is marked to market daily, whereas the forward contract is only due to be settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into each transaction, whereas the forward contract participants are in direct contact setting the forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid-ask spread.
D) All of the above are true.

Question 18

The major difference between currency futures and forward contracts is that futures contracts are standardized for ease of trading on an exchange market whereas forward contracts are specialized and tailored to meet the needs of clients.

Question 19

Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency futures market, and his expectations are correct, which of the following strategies would earn him a profit?

A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.

Question 20

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today's spot price her potential gain is ________ and her potential loss is ________.

A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000

Question 21

TABLE 7.1
Use the table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

Refer to Table 7.1. The May call option on pounds with a strike price of 1440 means:

A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above

Question 22

A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?

A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.

Question 23

A call option whose exercise price exceeds the spot price is said to be:

A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.

Question 24

TABLE 7.1
Use the table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

Refer to Table 7.1. What was the closing price of the British pound on April 18, 2009?

A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above

Question 25

A/An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.

A) American; European
B) American; British
C) Asian; American
D) European; American

Question 26

A call option whose exercise price is less than the spot price is said to be:

A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.

Question 27

The maximum gain for the purchaser of a call option contract is ________ while the maximum loss is ________.

A) unlimited; the premium paid.
B) the premium paid; unlimited.
C) unlimited; unlimited.
D) unlimited; the value of the underlying asset.

Question 28

A foreign currency ________ option gives the holder the right to ________ a foreign currency, whereas a foreign currency ________ option gives the holder the right to ________ an option.

A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above

Question 29

The main advantage(s) of over-the-counter foreign currency options over exchange traded options is (are):

A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above

Question 30

Which of the following is NOT true for the writer of a call option?

A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.

Question 31

Dash Brevenshure works for the currency trading unit of ING Bank in London. He speculates that in the coming months the dollar will rise sharply vs. the pound. What should Dash do to act on his speculation?

A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.

Question 32

A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes your profit if you choose to exercise the option before maturity?

A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$

Question 33

As a general statement, it is safe to say that businesses generally use the ________ for foreign currency option contracts, and individuals and financial institutions typically use the ________.

A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private

Question 34

A/An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.

A) American; European
B) American; British
C) Asian; American
D) European; American

Question 35

The price at which an option can be exercised is called the:

A) premium.
B) spot rate.
C) strike price.
D) commission.

Question 36

The buyer of a long call option:

A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above

Question 37

A call option on euros is written with a strike price of $1.30/euro. Which spot price maximizes your profit if you choose to exercise the option before maturity?

A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro

Question 38

Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should:

A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.

Question 39

An option whose exercise price is equal to the spot rate is said to be:

A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.

Question 40

TABLE 7.1
Use the table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

Refer to Table 7.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.

A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50

Question 41

As an option moves further out-of-the-money, delta moves toward ________.

A) 1
B) 0
C) -1
D) large negative numbers

Question 42

The ________ of an option is the value if the option were to be exercised immediately. It is the option's ________ value.

A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum

Question 43

Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call option has:

A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.

Question 44

Which of the following is NOT true for the writer of a put option?

A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.

Question 45

The buyer (long) of a put option:

A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the premium paid.
D) all of the above

Question 46

The writer of the option is referred to as the seller, and the buyer of the option is referred to as the holder.

Question 47

The value of a European style call option is the sum of two components:

A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.

Question 48

Compare and contrast foreign currency options and futures. Identify situations when you may prefer one vs. the other when speculating on foreign exchange.

Question 49

Which of the following is NOT a factor in determining the premium price of a currency option?

A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.

Question 50

The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).

Question 51

If the spot rate changes from $1.70/£ to $1.71/£ and there is an option with an initial premium of $0.033/£ and a delta of 0.5, then the new option premium would be:

A) $0.043/£.
B) $0.038/£.
C) $0.005/£.
D) $1.715/£.

Question 52

As an option moves further in-the-money, delta moves toward ________.

A) 0
B) -1
C) 1
D) large numbers

Question 53

Define and explain the logic for the time value of an option. Explain the value of the time value of an option for deep out-of-the money and deep in-the-money options.

Question 54

Most option profits and losses are realized through taking actual delivery of the currency rather than offsetting contracts.

Question 55

For a $1.50/£ call option with an initial premium of $0.033/£ and a lambda of 0.4, after an increase in annual volatility of 1 percent point - for example from 10% to 11% - the new option premium would be:

A) $0.036/£.
B) $0.037/£.
C) $0.004/£.
D) $1.54/£.

Question 56

Traders who believe volatilities will fall significantly in the near-term will:

A) sell futures now.
B) buy options now.
C) sell options now.
D) buy futures now.

Question 57

Foreign currency options are available both over-the-counter and on organized exchanges.

Question 58

Volatility is viewed the following ways EXCEPT:

A) historic.
B) forward-looking.
C) implied.
D) spot.

Question 59

The price of an option is always somewhat greater than its intrinsic value, since there is always some chance that the intrinsic value will rise between the present and the expiration date.

Question 60

Option premiums deteriorate at a/an ________ as they approach expiration.

A) increasing rate
B) proportional
C) decreasing rate
D) less than proportional rate

Question 61

Option values increase with the length of time to maturity. The expected change in the option premium from a small change in the time to expiration is termed delta.

Question 62

For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an increase in the foreign interest (the pound sterling rate) rate from 8% to 9% - the new option premium would be:

A) $0.035/£.
B) $1.48/£.
C) $0.031/£.
D) $0.032/£.

Question 63

The sensitivity of the option premium to a small change in the spot exchange rate is called the gamma.

Question 64

The Theta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.

Question 65

A trader who is buying options of longer maturities will pay more, and proportionately more, for the longer maturity options.

Question 66

The Rho of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.

Question 67

The Phi of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.

Question 68

The Lambda of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.

Question 69

If an American-style option possesses time value on any day up to expiration date, the option holder would get more by selling it than exercising it.

Question 70

The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).

Question 71

For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an increase in the U.S. dollar rate from 8% to 9% - the new ATM option premium would be:

A) $0.037/£.
B) $1.55/£.
C) $0.036/£.
D) $0.035/£.

Question 72

Option volatility is defined as the square root of the standard deviation of daily percentage changes in the underlying exchange rate.

Question 73

The majority of the option premium is lost in the final days prior to expiration.

Question 74

As long as the option has time remaining before expiration, the option will possess time the time value element.

Question 75

The Delta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.

Question 76

Standard foreign currency options are priced around the forward rate.

Question 77

Which of the following statements is NOT true about currency option pricing sensitivities?

A) The higher the delta, the more likely the option will move in-the-money.
B) Premiums rise with increases in volatility.
C) Premiums are relatively insensitive during the first days.
D) Increases in domestic interest rates cause decreasing call option premiums.

Question 78

If the rho of the specific option is known, it is easy to determine how the option's value will change as the spot rate changes.

Question 79

The higher the delta the greater the probability of the option expiring in-the-money.

Question 80

The value of any option that is currently in-the-money (ITM) is made up entirely of time value.