Deck 5: Currency Derivatives

Question 1

An advantage of a short straddle is that it provides the option writer with income from two separate sources.

Answer 1

True

Question 2

Non-deliverable forward contracts (NDFs) can be used to hedge existing positions in foreign currencies that are not convertible into dollars.

Answer 2

True

Question 3

If a currency's forward rate exhibits a discount, the currency is forced to appreciate.

Answer 3

False

Question 4

Hedgers should buy calls if they are hedging an expected outflow of foreign currency.

Question 5

Currency call options allow the purchaser to lock in the price paid for a currency. Therefore, they are often used by MNCs to hedge foreign currency payables.

Question 6

If an MNC desires to offset a forward contract that it previously created, it can simply ignore its obligation.

Question 7

Currency options are only traded on exchanges. That is, there is no over-the-counter market for options.

Question 8

Margin requirements require investors in futures contracts to make deposits with their respective brokerage firms when they take their position. The deposits are intended to minimize the credit risk associated with futures contracts.

Question 9

If an actual put option premium is less than what is suggested by the put-call parity relationship, arbitrage can be conducted.

Question 10

A speculator in futures contracts who expects the value of a foreign currency to depreciate would likely sell futures contracts.

Question 11

If the forward rate for a currency is less than the spot rate for that currency, the forward rate is said to exhibit a premium.

Question 12

The highest amount a buyer of a call or a put option can lose is the exercise price.

Question 13

An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign payables. To do so, the MNC can either sell the foreign currency forward or sell futures.

Question 14

Forward contracts are usually negotiated with a commercial bank, while futures contracts are traded on an organized exchange.

Question 15

Futures contracts are standardized with respect to delivery date and the futures price specified for the settlement date.

Question 16

Hedgers should buy puts if they are hedging an expected inflow of foreign currency.

Question 17

Forward contracts are the best technique for managing exposure arising from project bidding.

Question 18

If the futures rate is above the forward rate, actions by rational investors would put upward pressure on the forward rate and downward pressure on the futures rate.

Question 19

If a currency's forward rate exhibits a premium, that currency is forced to depreciate.

Question 20

If the futures rate is lower than the forward rate, astute investors would attempt to simultaneously buy futures and sell forward. Such actions would place downward pressure on the futures price and upward pressure on the forward rate.

Question 21

When the current exchange rate is less than the strike price, a call option with that strike price will be in the money and a put option with that strike price will be out of the money.

Question 22

Due to put-call parity, we can use the same formula to price calls and puts.

Question 23

Because constructing a long straddle in a foreign currency requires payment of two option premiums, the straddle becomes profitable only if the foreign currency appreciates or depreciates substantially.

Question 24

The currency futures markets are regulated by the International Monetary Fund.

Question 25

A straddle is a speculative strategy that involves the purchase of both a call and a put.

Question 26

Since corporations have specialized needs, they usually prefer futures contracts to forward contracts for hedging purposes.

Question 27

A European option can be exercised at any time prior to maturity, while an American option can only be exercised at maturity.

Question 28

A high spot price relative to the strike price will result in a relatively high premium for a call option and a relatively high premium for a put option.

Question 29

A contingency graph for the purchaser of a call option compares the price paid for the option to the payoffs received under various exchange rate scenarios.

Question 30

Margin is used in the forward market to mitigate default risk.

Question 31

The option exchanges in the United States are regulated by the Consumer Finance Protection Bureau and the Federal Trade Commission.

Question 32

Futures and options are available for cross rates.

Question 33

The price of a futures contract will generally vary significantly from that of a forward contract.

Question 34

The choice of a basic versus a conditional option depends on expectations about the currency's exchange rate over the period of concern.

Question 35

A straddle involves the purchase of either two call or two put options at the same exercise price.

Question 36

Forward contracts are usually liquidated by actual delivery of the currency, while futures contracts are usually liquidated by offsetting transactions.

Question 37

Options can be traded on an exchange or over the counter.

Question 38

A currency call option grants the right to sell a specific currency at a designated price within a specific time period.

Question 39

The writer of a call option is obligated to sell the underlying currency to the buyer of the option if the option is exercised.

Question 40

A European option can only be exercised at the expiration date, while an American option can be exercised any time prior to the expiration date.

Question 41

If an investor who has previously purchased a futures contract wishes to liquidate her position, she would sell an identical futures contract with the same settlement date.

Question 42

The lower bound of the call option premium is the greater of zero and the difference between the spot rate and the exercise price; the upper bound of a currency call option is the spot rate.

Question 43

The lower bound of a put option premium is the greater of zero and the difference between the exercise price and the spot rate; the upper bound of a currency put option is the exercise price.

Question 44

Both call and put option premiums are affected by the level of the existing spot rate relative to the strike price, the length of time before the expiration date, and the potential variability of the currency.

Question 45

If a currency call option is in the money, then the present exchange rate exceeds the strike price.

Question 46

Both call and put option premiums are affected by the level of the existing spot price relative to the strike price; for example, a high spot price relative to the strike price will result in a relatively high premium for a call option but a relatively low premium for a put option.

Question 47

It is possible to have an opportunity loss when using futures to hedge.

Question 48

Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets.

Question 49

There are no transactions costs associated with trading futures or options.

Question 50

The forward premium is the price specified in a call or put option.

Question 51

The writer of a put option has a right, but not an obligation, to buy the underlying currency from the option buyer.

Question 52

A straddle can only be achieved if the exercise prices of put and call options are the same.

Question 53

Since futures contracts are traded on an exchange, the exchange will always take the "other side" of the transaction in terms of accepting the credit risk.

Question 54

An option writer is the seller of a call or a put option.

Question 55

If a currency put option is out of the money, then the present exchange rate is less than the strike price.

Question 56

A currency put option is a contract specifying a standard volume of a particular currency to be exchanged on a specific settlement date.

Question 57

American-style options can be exercised any time up to maturity.

Question 58

With a bull spread, the spreader believes that the underlying currency will appreciate substantially, even more so than with a strangle.

Question 59

Managers of MNCs are typically expected to use currency derivatives for speculation in order to improve profits.

Question 60

If an investor who previously sold futures contracts wishes to liquidate his position, he could sell futures contracts with the same maturity date.

Question 61

The disadvantage of a long strangle relative to a long straddle is that the underlying currency has to fluctuate more prior to expiration.

Question 62

​Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:

A) ​$1,562.50.
B) ​-$1,562.50.
C) ​-$1,250.00.
D) ​-$625.00.

Question 63

Conditional currency options are:

A) options that do not require premiums.
B) options where the premiums are canceled if a trigger level is reached.
C) options that allow the buyer to decide what currency the option will be settled in.
D) None of these are correct.

Question 64

The writer of a currency call option is obligated to buy the currency if the option is exercised.

Question 65

Research has found that the options market is:

A) efficient before controlling for transaction costs.
B) efficient after controlling for transaction costs.
C) highly inefficient.
D) None of these are correct.

Question 66

The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward ____ is ____ percent.

A) discount; 1.9
B) discount; 1.8
C) premium; 1.9
D) premium; 1.8

Question 67

Assume that the British pound futures price for September is $1.60. Given that 62,500 units are in a British pound futures contract, the seller of British pound futures will receive $____ on the delivery date.

A) 39,062.50
B) 100,000.00
C) 48,000.00
D) 87,062.50

Question 68

The 180-day forward rate for the euro is $1.34, while the current spot rate of the euro is $1.29. What is the annualized forward premium or discount of the euro?​

A) ​7.46 percent premium
B) ​7.46 percent discount
C) ​7.75 percent premium
D) ​7.75 percent discount

Question 69

A U.S. corporation has purchased currency call options to hedge a 70,000 pound (£) payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally?

A) $33,600
B) $46,900
C) $44,100
D) $36,400

Question 70

​If you have an options position in which you might be obligated to buy euros, you are a:

A) ​call writer.
B) ​put writer.
C) ​put buyer.
D) ​futures seller.

Question 71

Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now?

A) $44,500.
B) $45,000.
C) $526 million.
D) $47,500.

Question 72

The spot rate of the British pound is quoted at $1.49. The 90-day forward rate exhibits a 2 percent discount. What is the 90-day forward rate of the pound?

A) $1.52
B) $1.61
C) $1.37
D) $1.46

Question 73

You purchase a put option on Swiss francs for a premium of $.02, with an exercise price of $.61. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58, your net profit per unit is:

A) -$.03.
B) -$.02.
C) -$.01.
D) $.02.
E) None of these are correct.

Question 74

Which of the following is true regarding the currency options market?

A) Hedgers and speculators both use currency options to attempt to lower risk.
B) The currency options offered by commercial banks are more liquid and have a smaller bid/ask spread than the options traded on an exchange.
C) When transaction costs are controlled for, the currency options market is efficient.
D) All of these are correct.

Question 75

​When you own ____, there is no obligation on your part; however, when you own ____, there is an obligation on your part.

A) ​call options; put options
B) ​futures contracts; call options
C) ​forward contracts; futures contracts
D) ​call options; forward contracts

Question 76

​As mentioned in the text, the most common maturities for forward rates are:

A) ​30, 60, 90, 180, and 360 days.
B) ​one, three, six, and twelve years.
C) ​5, 30, and 360 days.
D) ​two, three, and five weeks

Question 77

​Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?

A) ​Purchase a call option on francs.
B) ​Sell a futures contract on francs.
C) ​Obtain a forward contract to purchase francs forward.
D) ​All of the above are appropriate strategies for the scenario described.

Question 78

Assume no transactions costs exist for any futures or forward contracts. The price of British pound futures with a settlement date 180 days from now will:

A) definitely be above the 180-day forward rate.
B) definitely be below the 180-day forward rate.
C) be about the same as the 180-day forward rate.
D) None of these are correct; there is no relation between the futures and forward prices.

Question 79

​When the futures price on euros is below the forward rate on euros for the same settlement date, astute investors may attempt to simultaneously ____ euros forward and ____ euro futures.

A) ​sell; sell
B) ​buy; sell
C) ​sell; buy
D) ​buy; buy

Question 80

The 90-day forward rate for the euro is $1.07, while the current spot rate of the euro is $1.05. What is the annualized forward premium or discount of the euro?

A) 1.9 percent discount
B) 1.9 percent premium
C) 7.6 percent premium
D) 7.6 percent discount