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Derivatives Securities and Markets

Problem Set #1

Question #1a

A US company knows it will have to pay 3 million euros in three months. The current exchange rate is 1.1500 dollars per euro.  Briefly discuss how forward and options contracts can be used by the company to hedge its exposure.

Question #1b

A trader enters a short forward contract on 100 million yen. The forward exchange rate is $0.0080 per yen. How much does the trader gain or lose if the exchange rate at the end of the contract: (a) $0.0074 per yen; (b) $0.0091 per yen?

Question #1c

It is May and a trader buys a September European call option with a strike price of $20. The stock price is $18, and the option price is $2. Describe the investor’s cash flows if the option is held until September and the stock price is $25 at that time.

Question #1d

Suppose you own 5,000 shares that are worth $25 each. How can put options be used to provide you with insurance against a decline in the value of your holding over the next four months?

Question #1e

An investor writes a December put option with a strike price of $30. The price of the option is $4. Under what circumstances does the investor make a gain?