Deck 8: Foreign Currency Derivatives

Question 1

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

Answer 1

futures

Question 2

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

Answer 2

Foreign currency futures are standardized contracts that lend themselves well to speculation purposes but less so for hedging purposes. The standardized nature of the futures contract makes it easy to trade futures and to make bets about general changes in the value of currencies. Forward contracts are better for hedging in that they are tailored to meet the specific needs of the client, typically a business, and can be quite useful in reducing exchange rate risk. Banks are involved in the foreign currency futures market in part to offset positions that they may have taken in the forward markets as dealers.

Question 3

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

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

Answer 3

sold; short

Question 4

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

Question 5

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

Question 6

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 7

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

Question 8

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 9

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 10

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 11

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 12

An ________ option can be exercised only on its expiration date, whereas 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 13

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 14

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 15

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 16

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

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

Question 17

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 18

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 19

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 20

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 21

TABLE 8.1
Use the below mentioned table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).
Refer to Table 8.1. 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

Andrea Cujoli 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/$. Andrea thinks the yen will move to ¥128.00/$ in the next six months. If Andrea 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 23

Andrea Cujoli 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/$. Andrea thinks the yen will move to ¥128.00/$ in the next six months. If Andrea's expectations are correct, then she 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)She could not profit in the forward market.

Question 24

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 25

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 26

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 27

TABLE 8.1
Use the below mentioned table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).
Refer to Table 8.1. 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 28

TABLE 8.1
Use the below mentioned table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).
Refer to Table 8.1. 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 29

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

Question 30

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 31

Andrea Cujoli 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/$. Andrea thinks the yen will move to ¥128.00/$ in the next six months. If Andrea buys $100,000 worth of yen at today's spot price and sells within the next six months at ¥128/$ she will earn a profit of ________.

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

Question 32

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

Question 33

Andrea Cujoli 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/$. Andrea thinks the yen will move to ¥128.00/$ in the next six months. Andrea should ________ at ________ to profit from changing currency values.

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

Question 34

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 35

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 36

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 37

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 38

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 39

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 40

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 41

The buyer of a long 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 42

The authors quote an essay on risk from Peter Bernstein in which he states each of the following EXCEPT:

A)It is hubris to believe that we can put reliable and stable numbers on the return of the stock market over the next 2, 20, or 50 years.
B)It is rational to use probability instead of timing to demonstrate that an event with low probability is therefore unlikely to ever occur.
C)The science of risk management is capable of creating new risks even as it brings old risks under control.
D)All of the above are part of Peter Bernstein's essay.

Question 43

Other things equal, the price of an option goes up as the volatility of the option decreases.

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 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 46

Volatility cannot be directly observed for calculation purposes of the option pricing model. Therefore, it may be determined from

A)historic volatility.
B)forward-looking volatility.
C)implied volatility.
D)any of the above

Question 47

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

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

Question 48

Andrea Cujoli 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/$. Andrea would earn a higher rate of return by buying yen and a forward contract than if she had invested her money in 6-month US Treasury securities at an annual rate of 2.50%.

Question 49

Assume that a call option has an exercise price of $1.50/³. At a spot price of $1.45/³, 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 50

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

Question 51

________ volatility are calculated by being backed out of the market option premium values traded.

A)Historic
B)Forward-looking
C)Implied
D)none of the above

Question 52

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 53

Major corporate financial disasters related to financial derivatives continue to be a problem in global business.

Question 54

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

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

Question 55

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 56

Volatilities are the only judgmental aspect of currency option pricing and are therefore, the least important component therein.