CURRENCY OPTION CONTRACTS REVIEW QUESTIONS
1. Briefly explain the advantages of using OTC Currency Options in comparison to
exchange- traded instruments.
2. Briefly explain the following terms as they relate to option contract:
(i)
strike price
(ii)
option Premium
(iii)
Base Currency
(iv)
Intrinsic Value
3. NBAA Adapted
A Tanzanian company expects to receive US$100,000 and TZS 20,000,000 from a customer
in September 2018. It is worried that the US$ will fall in value over the next few months
and is thinking of hedging the currency exposure with an Over the Counter (OTC)
current option. The following option prices are available for September 2018 expiry date,
for call and put options on the US$ in exchange for the Tanzanian shillings (TZS). Prices
are quoted in TZS per US$
Strike Price
Call Option
Put Options
TZS 2,600
TZS 2.50
TSZ 1.05
TZS 2,400
TZS 1.55
TSZ 2.10
REQUIRED:
Show how an option hedge would be constructed, and what would be the option cost for
each of the two strike prices.
(5 marks)
Assume that the spot exchange rate in September 2018 when the options expire is TZS
2,500/US$. Explain the action the company should take and indicate the effective
exchange rate for each of the two strike prices. (7 marks)
4. As it is now May, assume a UK- based firm has imported from USA and is invoinced
at US$ 2,900,000, payable on the 31st October. The company is also due to receive from
its customers an amount of ₤1,000,000 and US$ 1,000,000 simultaneously both payable
on 31st October. More data is provided as below:
Current spot rate is US$ /₤ 1.8773 – 1.8791 The December Sterling option contracts
(with contract size ₤ 125,000) are quoted as;
Exercise Prices:
US$ 1.85
US$ 1.90
US$ 1.95
Premiums in cents / ₤
December Options:
Calls
Puts
15.6
5.36
12.45
9.23
8.25
11.47
Suppose the UK firm decides to use the sterling options with an exercise price of US$
1.90/₤ to hedge its position; what would be the outcome if;
(a)
(b)
As at 31st December, the spot rate US$/₤ is
1.9245 – 1.9525
st
As at 31 December, the spot rate US$ / ₤ is 1.8665 – 1.8675
5. A British Company needs to hedge the receipt of US $ 50,000,000 from and American
customer at the end of June. The spot rate is $ 1.4461 - $ 1.44921 ₤ and the 30 June
forward rate is $ 1.4050 - $ 1.41011 ₤. The following currency options are available:
Sterling ₤ 156,250 contracts (cents per ₤)
Exercise price
calls
puts
$/₤
June
June
1.4000
5.74
7.89
1.4250
3.40
9.06
1.4500
1.94
11.52
1.4750
0.89
14.69
Assume that the company chooses to hedge the receipt of $ 50,000,000.
Required:
If the company chooses an exercise price of US$1.45/₤, demonstrate the result if the
spot rate on June 30th is
(i)
$1.44/₤ - $ 1.55/ ₤
(ii)
$1.30/₤ - $ 1.35/ ₤
6. Prices / premiums on 1 June for sterling traded currency options on the forex stock
exchange are shown in the following table
Sterling ₤ 31250 contracts (cents per ₤)
Calls
puts
Exercise price
September December
September
December
September
$/₤
1.50
5.55
7.95
0.42
1.95
1.55
2.75
3.85
4.15
6.30
1.60
0.25
1.00
9.40
11.20
Prices are quoted in cents per ₤ and the current spot exchange rate is $ 1.5404 - $ 1.5425.
Stark inc, a US company is due to receive ₤ 3,750,000 from a debtor in four month’s time
at the end of September. The treasure decides to hedge this receipt using September ₤
traded options.
Required:
Compute the results by using options hedges, illustrating the results with all three
possible option exercise prices if by the end of September, the spot exchange rate moves
to
(i)
$ 1.48/ ₤
(ii)
$ 1.57/ ₤
(iii)
$ 1.62/ ₤
Qn. 7 NBAA Adopted
a) Briefly explain the meaning of currency options and their main uses and major
drawbacks.
b) Answer the following short questions. Show your computations:
(i) On June 10, the closing rate of French Francs was $0.18. Puts which would
mature on September 19 with a strike price of $0.19, were traded at $0.08. What
was the intrinsic value of the put on June 10?
(ii) The premium for a call on British Pound with a strike price of $1.75 is $0.07.
What is the break even point in $ for the buyer of the call?
(iii) A US Company wants to use a currency put option to hedge 15 million French
Francs in account receivable. The premium of the currency put option with a
strike price of $0.22 is $ 0.07. What is the total amount of Dollars received after
accounting for the premium payment if the option is exercised?
(iv) The call premium per Canadian Dollar on April 19 is $ 0.04, the expiration date
is September 19 and the price is $ 0.80. K.Y. John purchased three calls options
for Canadian Dollars [Can S 150,000]. He decides to let his options expire
unexercised on September 19 because the spot rate for the Canadian Dollar fell
to $0.70 on that day. What is his total loss from this speculation?
(v) The spot rate is US$0.50 per AUD. The annual interest rates are 12 percent for
the United States dollar and 8% for AUD. If these interest rates remain
constant, then what is the market forecast of the spot rate for the AUD in five
years?
Qn.8 NBAA & ACCA adapted (Slightly modified)
Purple Inc. a US company, imports goods from the UK and is invoiced for £2,082,500
payable on the 15th January, while at the same time puple is due to receive £1,000,000 and
US$ 4,000,000 from its two esteemed customers respectively. The company therefore
wishes to hedge its position using options at an exercise price of $1.75. Data is as follows:
$/£ Spot
1.7120 – 17150
£options:
Contra size is £62,500
Exercise
contracts
Price
£ calls
£puts
1.65
15.10
4.25
1.70
10.37
12.30
1.75
6.25
15.15
Contract prices are in cents/£
Required
(a) Show the hedge position and compute its cost.
(b) Illustrate the action the company will take on the 15th January if the S/£ spot rate
at that time is 1.8420-1.8450
(c) Calculate the net saving that the company makes as a result of its option hedge.
Qn.9. ACCA Adapted (Slightly modified)
PINK UNK PLC is a UK-based exporter. It has invoiced a customer for $1,750,000
payable on 1st August.The current $/£ spot is: 1.5190 - 1.5230
It wishes to hedge its FX risk exposure using traded currency options. On LIFFE, the £
September contracts with an exercise price of $1.50 has a premium of 8c/ £. Option
contracts are in respect of £125.000. Option premiums are quoted in cents/£
(a)
Set up the option hedge and compute the option premium payable.
(b) If, on 1st August, the $/£spot is 1.6470 – 1.6500 advise pink ink on whether it
should allows its options to lapse or exercise them.
(c)
What would be the minimum premium on £ September options on 1st August
to make the option be at the break even point?
QN 10: (NBAA ADAPTED)
(a)
Discuss the factors that may persuade a company to hedge an interest rate
exposure by using over the Counter (OTC) option rather than interest rate future.
(6marks)
(b) In assessing investment opportunities in a foreign country, it is important for a parent
firm to take into consideration the risk arising from the fact that the investments are
located in a foreign country.
REQUIRED:
(a) what do you think is so unique about international finance that it requires special
attention in today’ business practices?(8marks)
(b) Mabibo Company Ltd, a leading cashew nut processor and exporter in Tanzania,
expects that it will need Malawian Kwacha (MK) 100 million a year. The existing spot
rate of the Malawian Kwacha is TZS 12. the one year forward rate of the Malawian
Kwacha is TZS 12.5. Mabibo created distribution for the future spot rate in one year as
follows:
Future spot rate
(TZS)
Profitability
12.0
30%
12.5
50%
13.0
20%
Assuming that one year input options on Malawi Kwacha are available, with exercise
prices of TZS 12.6 and a premium of TZS 0.8 per unit. One year call options on Malawian
Kwacha are available with an exercise price of TZS 12 and a premium of TZS 0.6 per unit.
REQUIRED:
As a newly appointment company Treasure, critically analyze the situation and
accordingly advice the management on the best position to take.
QUESTION 11: OPTIONS (NBAA Adapted)
(a) Discuss the relative advantages of using exchange traded interest options and over
the counter (OTC) interest option and outline the main determinants of interest
rate option prices.
(b) Premier company a Tanzanian Company, imports goods from UK and is invoiced
for £216,500 payable on the 15th January. The company wishes to hedge using
currency option at an exercise price of Tshs 1,750. Data is as follows:
Ths/£Spot
£options
Exercise Price
Tshs
1,650
1,700
1,750
1,712 – 1,715
contract size is £ 12,500
March Contract
£ Calls
90.25
80.45
62.50
£ Calls
40.30
90.80
95.80
REQUIRED:
(i)
Show the hedge position and compute its cost
(ii)
Illustrate the action the company will take on the 15th January if the Tshs/£ spot
rate at that time is Tshs 1,842 – 1,845
(5marks)
(iii)
Calculate the net saving that the company makes as a result of its option hedge.
QUESTION 12: FUTURE & OPTIONS (NBAA Adapted)
(a) Explain the term “risk management” in respect of interest rates and discuss how
interest rate risk might be managed by forward rate agreement, futures and options.
(10marks)
(b)
Opportunity Company is a Great Britain based exporter. It has invoiced a customer
in the United States of America for US$1,058,000 payable on 30th June.
The current US$ spot is 1.7296 – 1.7330
The company wishes to hedge its foreign exchange risk exposure using traded
currency option contract is in respect of £25,000. Option premium are quoted in
cents/£.
REQUIRED:
(i) Set the option hedge and calculate the option cost. (Hint: round up the required
number of calls to the nearest whole number)
(ii) If on 1st June, the US$ spot is 1.8460 – 1.8550 advice opportunity company on
whether it should allow the options to lapse or exercise them. (7marks)
QUESTION 13: NBAA Adapted)
REQUIRED:
(i) If the current exchange rate is TZS 1275/US$ decompose the values of each of the
options into intrinsic and time value.
(ii) Explain why an option that is out of the money can still command positive
premiums.
(iii) Suppose you can sell or buy any of these options and you can also borrow or lend
at 8% p.a, use the call parity condition to establish if the pricing of the option offer
any arbitrage opportunity. Show how you can exploit any such opportunity. (For
consistency, assume one option contract and one unit of currency.) (8marks)
QUESTION 14: (NBAA Adapted)
(a)A Tanzania speculator is considering the purchase of five three-month Japanese Yen
call option contracts will a strike price of TAS 15.81 Japanese. The premium is TAS 0.15
per Yen and the contract size is 1,000,000 Japanese Yen, the spot price is ¥: TAS 12.75 –
13.80. The speculator believes the Yen will appreciate to ¥: TAS 17.70 – 19.80 over the
next three months.
REQUIRED:
As the speculator’s assistance you have been asked to do the following:
(i) Determine the speculator’s total profit on the five contracts if the Yen appreciate to
¥: TAS 17.70 (2marks)
(ii) Determine the speculator’s total profit on the five contract if the Yen appreciates
only to the forward rate (2marks)
(iii) Determine the future spot rate at which the speculator will realize a speculative
profit amounting to TAS 1,000,000 (2marks)
(iv) Determine the future spot rate at which the speculator will realize a speculative
profit amounting to TAS 1,000,000 (4marks)
QUESTION 15 (NBAA Nov 2016)
(a) Omwami Premium Export Ltd (OPEL), is a seasoned exporter of Arabica and Robusta
roasted coffee beans to Europe and Asia. After having stayed for a long time without
a full time finance expert, OPEL has finally employed you as a finance manager. In
a meeting involving the Manager and you, the Managing Directors (MD), the
Marketing Manager and you, the Managing Director expressed his concern about the
recent trend of the Tanzanian shilling strengthening against the Pound. He was
worried that if the TZS keeps on appreciating in value, OPEL will make a loss on a
consignment exported to the payment United Kingdom, whose payment £40,000 will
be received in 90 days. The Marketing Manager told the Managing Director that he
has no reason to be anxious since OPEL will use forward contract as they have always
done, to protect the value of their receivables. It was observed that the spot rate was
TZS.2,500 per Pound. The 90-days forward rate for the pound is TZS.2,400.
You have observed that banks are offering options on the pound and a put option
with a strike price of TZS 2,300 and 90-days maturity has a premium of TZS 50. You
propose that this alternative need to be considered.
REQUIRED:
(i)
(ii)
Explain to the Managing Director and the Marketing Manager on how he put
option will benefit OPEL as compared to the forward contract. (5 marks)
Show them under what condition OPEL would exercise the put option and
when they would break even
Assume the spot rate when £ 40,000is received range from TZS 2,000 to TZS 2,800 in
intervals of TZS 100
(2 marks)
(iii)
(iv)
Compute the net realizable answers with the put option and compare them
with the realization under forward contract (4 marks)
Explain to the Managing Director any two factors affecting the option value
(b) Briefly explain the main features of a just-in-time inventory system. Explain any two
factors that would limit its application in Tanzania. (6 marks) (Total: 20 marks)