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QUESTION, MAY/JUNE 2018
2A currency dealer 1s cons1denng trading between Australian dollar (AUD) and Norwegian Krone
(NOK) A put option allows the holder to sell NOK400 000 now at an exercise exchange rate of
0.2540 (AUD/NOK) If the premium paid 1s 0.7 Australian cents for 1each NOK, calculate the net
payoff at the following spot exchange rates
(a)
o 2410
[2]
(b)
0 2786
[2]
(c)
0 1856
[2]
(d)
At what exchange rate will the holder break even?
[2]
ANSWERS
Short Notes
Any point below the exercise exchange rate is necessary to exercise even though it will not give a positive
profit to the buyer, but it deducts the amount paid in the form of premium.
For Put Option (Exercise rate -Spot rate -Premium) X Amount
a. ((0.254-0.2410)-0.007)) X NOK400 000 =AUD2400
b. ((0.254-0.2786)-0.007)) X NOK400 000=(AUD12,640)
c. ((0.254-0.1856)-0.007)) X NOK400 000=AUD24,560
d)BEP =Exercise rate – Premium
(0.254-0.007) = 0.2470
OR
Exercise
Rate
0.254
0.254
0.254
Spot
rate
0.2410
0.2786
0.1856
Exercise
Decision
YES
NO
YES
Option type
Gross
Proceeds
AUD101 600
AUD101 600
AUD101 600
Spot exchange rate is
greater than strike
price
Exercise
Value
AUD96 400
AUD111 440
AUD74 240
Option
Premium
AUD2 800
AUD2 800
AUD2 800
Spot exchange rate is equal
to strike
price
Net Proceeds
AUD2 400
(AUD12 600)
AUD24 560
Spot exchange rate is less
than strike
Price
Calls
In-The-Money
At-The-Money
Out-Of-The-Money
Puts
Out-Of-The-Money
At-The-Money
In-The-Money
Interpretation of the option outcomes
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Therefore, Interpret the above put option outcomes.
Question
2
2.1 A call option allows the holder to buy US$100 000 at an exercise exchange rate of 1.8000 (AUD/US$). If the
premium paid is 0.5 Australian cents for each US$, calculate the net payoff at the following spot exchange
rates:
(a)
1.8040
[1]
(b) 1.8260 [1]
(c) 1.7870 [1]
(d) At what exchange rate will the holder break even? [2]
Short notes
Call options give the buyer the right to buy the underlying currency. The holder of a call option has
the right to buy the underlying currency, while the seller of the call option has the obligation to sell
the underlying currency if and when the holder thereof takes up the right
: A call option is a right to buy a currency at a specified exchange rate, on or before the expiration
of the call option contract. The only point to exercise a call option is when the spot exchange rate
is above the exercise price. Any point above the strike price is worthwhile exercising the call
option because it helps reducing the loss on price paid for the premium.
Answer
(a) At 1.8040 the holder will exercise, buying the USD at 1.800. By selling spot at 1.8040, the following
net loss will be made:
100 000 x (1.8040 – 1.800 – 0.005) = -100
(b) At 1.8260 the holder will also exercise, making the following net profit:
100 x (1.8260 – 1.800 – 0.005) = 2100
(c) At 1.7870 the holder will not exercise, losing the premium. The following net loss will be made:
100 000 x (-0.005) = -500
(d) The break-even spot rate, which produces zero net profit, can be calculated from the following
equation:
100 x (S – 1.800 – 0.005) = 0, which gives S = 1.8050.
Interpret the above outcomes (in the money, out of the money, at the money)
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