Question 1

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

Accepted Answer

A short straddle involves selling both a call option and a put option at the same strike price and expiration date. This allows the option writer to collect premiums from both options, providing income from two separate sources.

Question 2

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

Accepted Answer

NDFs are specifically designed to hedge against currency risk in non-convertible currencies, so this statement is true.

Question 3

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

Accepted Answer

If a currency's forward rate exhibits a discount, it means that the forward rate is lower than the current spot rate. This implies that the market is expecting the currency to depreciate in value, not appreciate.

Question 4

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

Accepted Answer

Hedgers use options to hedge against unfavorable market movements. In the case of an expected outflow of foreign currency, buying calls can help protect against a rise in the foreign currency's value.

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.

Accepted Answer

Currency call options can provide a hedge against unfavorable currency fluctuations, allowing MNCs to lock in a favorable exchange rate for their foreign currency payables.

Question 6

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

Accepted Answer

Ignoring a forward contract obligation is not a valid way to offset a contract. The MNC would need to enter into an equal and opposite forward contract to effectively offset the first contract.

Question 7

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

Accepted Answer

Currency options can be traded both on exchanges and over-the-counter (OTC) markets. OTC options are customized contracts between two parties and are not standardized like exchange-traded 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.

Accepted Answer

Margin requirements do indeed require investors to make deposits with their brokerage firms in order to minimize credit risk in 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.

Accepted Answer

According to put-call parity, the premium of a put option should be equal to the premium of a call option plus the present value of the strike price minus the underlying asset price. If the actual put option premium is less than what is suggested by put-call parity, then an investor can buy the put option, sell the call option, and buy the underlying asset. This will result in a risk-free profit, eliminating the price discrepancy. Therefore, 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.

Accepted Answer

Selling futures contracts allows the speculator to profit if the value of the currency does indeed depreciate, as they can buy it at a lower price and then sell it at a higher price at the expiration date of the contract.

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.

Accepted Answer

If the forward rate for a currency is less than the spot rate for that currency, the forward rate is said to exhibit a discount, not a premium. A premium occurs when the forward rate is greater than the spot rate.

Question 12

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

Accepted Answer

This statement is false. The highest amount a buyer of a call or a put option can lose is the premium paid for the option. The exercise price only comes into play if the option is exercised.

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.

Accepted Answer

An MNC hedging its exposure to foreign payables would buy forward or futures contracts in the foreign currency, not sell them, to lock in the cost of the payable.

Question 14

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

Accepted Answer

Forward contracts are usually negotiated with a commercial bank or other financial institution, while futures contracts are traded on organized exchanges such as the Chicago Mercantile Exchange or Intercontinental Exchange.

Question 15

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

Accepted Answer

Futures contracts are standardized with respect to the quantity and quality of the commodity or asset, not the futures price. The price is determined by market forces. The delivery date (or settlement date) is standardized as part of the contract specifications.

Question 16

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

Accepted Answer

Buying puts allows hedgers to lock in a minimum exchange rate, protecting against a decline in the value of the foreign currency they expect to receive.

Question 17

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

Accepted Answer

Forward contracts, while useful for hedging against currency risk, are not necessarily the best technique for all types of exposure arising from project bidding, as their effectiveness depends on the nature of the exposure and the availability of matching forward contracts. Other techniques, such as options or diversification, might be more suitable depending on the specific risks involved.

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.

Accepted Answer

Rational investors would arbitrage the difference by selling futures contracts (which are priced higher) and buying equivalent forward contracts (which are priced lower), leading to increased demand for forwards (pushing their prices up) and increased supply of futures (pushing their prices down) until the prices converge.

Question 19

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

Accepted Answer

A currency's forward rate exhibiting a premium means that the currency is expected to appreciate in the future, not 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.

Accepted Answer

The answer of If the futures rate is lower than...

Quiz 5: Currency Derivatives