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SM 12

The document contains a series of questions related to currency options and swaps, focusing on various financial scenarios involving foreign exchange rates, options, and hedging strategies. It includes calculations for potential payoffs, premiums, and the evaluation of different hedging methods such as forward contracts, money market hedges, and options. Additionally, it discusses parallel loans between companies in different countries and the implications of currency fluctuations on financial transactions.

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5 views4 pages

SM 12

The document contains a series of questions related to currency options and swaps, focusing on various financial scenarios involving foreign exchange rates, options, and hedging strategies. It includes calculations for potential payoffs, premiums, and the evaluation of different hedging methods such as forward contracts, money market hedges, and options. Additionally, it discusses parallel loans between companies in different countries and the implications of currency fluctuations on financial transactions.

Uploaded by

zflevi40
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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J.K.SHAH CLASSES FINAL C.A.

– STRATEGIC FINANCIAL MANAGEMENT

CURRENCY OPTIONS & SWAPS


Question 1:
It is around February end and the spot $/ £ rate is $1.4/1. You are convinced that the £ will
weaken by May end to about $ 1.3 / £ 1. Sterling December put options with a strike price of $
1.39 are being traded at a premium of £ 500 per contract. The sterling contract size is £ 25000.
You are required to work out possible pay offs if the spot rate at expiration is (a) $1.3 (b) $1.5
and (c) $1.39

Question 2:
A company is tendering for the sale of equipment’s to a US company for $ 3 million, settlement
due in 3 months’ time. The current spot rate is $ 1.58 per 1 £. However the company is worried
about the dollar weakening against the Pound thus making the sale less profitable. The
company has been offered a 3 month put option on US dollar at $1.60 per £ 1 costing 2 cents
per Pound. What is the total premium outflow?

Question 3:
Hessey international plc has recently purchased a consignment of cleaning fluid from a United
States supplier for $3,00,000 payable in 3 months’ time. Recently the company has
experienced foreign exchange losses on similar deals and the financial director has decided
that henceforth all transaction exposure will be covered. After discussion with the bank the
following data have been made available:

Foreign exchange market


$/£
Spot rate 1.5000 - 1.5050
3 month forward premium on $ 1.00 - 0.80 cents

Money Market
Base rates are 18% per annum both in UK and USA.
Hessey can borrow at 2% above and deposit at 2% below the relevant base rate in either
countries

Option
The Bank has offered a call option on $300000 at an exercise price of $ 1.49 / £ at a cost of £
3000 payable in arrears.
The financial director is also aware that transaction exposure may be hedged by the use of
financial futures exchanges but is uncertain of the advantages they offer as exposed to
services offered by banks.

You are required:


(a) To calculate the net cost of the transaction assuming it was covered in:
(i) The forward foreign exchange market.
(ii) The money market
(b) To explain to the financial director the nature of the foreign exchange risk cover provided
by the call option and calculate the exact future spot rate at which the option would start
to give a cheaper cost than the forward contract

:1: REVISION NOTES – MAY ‘19


J.K.SHAH CLASSES FINAL C.A. – STRATEGIC FINANCIAL MANAGEMENT
Question 4:
XYZ Ltd a US firm will need £ 3,00,000 in 180 days. In this connection the following
information is available:
Spot 1 £ = $2.00
180 day forward rate of £ as of today = $1.96

Interest rates are as follows:


UK US
180 day deposit rate 4.5% 5%
180 day borrowing rate 5% 5.5%
A call option of £ that expires in 180 days has an exercise price of $1.97 and a premium of
$0.04. XYZ Ltd has forecast the spot rates 180 days hence as below:
Future rate Probability

$1.91 25%
$1.95 60%
$2.05 15%

Which of the following strategy would be most preferable to XYZ Ltd :


(a) forward market
(b) Money market hedge
(c) Option contract
(d) No hedging
Show calculation in each case.

Question 5:
On 19th April following are the spot rates:
Spot EUR / $ 1.20000; USD / INR = 44.8000

Following are the quotes of European Options:


Currency Pair Call / Put Strike Price Premium Expiry Date

EUR / USD Call 1.2000 $ 0.0375 July 19


EUR / USD Put 1.2000 $ 0.04 July 19
USD / INR Call 44.8000 ₹ 0.12 Sep 19
USD / INR Put 44.8000 ₹ 0.04 Sep 19
(i) A trader sells an at the money spot straddle expiring at 3 months (July 19). Calculate
gain or loss if 3 months later the spot rate is EUR / USD = 1.2900.
(ii) Which strategy gives a profit to the dealer if 5 months later (Sep 19) expected spot rate is
USD / INR = 45.00. Also calculate the profit for a transaction of USD 1.5 million.

:2: REVISION NOTES – MAY ‘19


J.K.SHAH CLASSES FINAL C.A. – STRATEGIC FINANCIAL MANAGEMENT
Question 6:
Apple Inc, a US based Company wishes to lend $500,000 to its Japanese subsidiary. At the
same time Toyota Motors, a Japan based company, is interested in making a medium term
loan of approximately the same amount to its USA subsidiary. The two parties are brought
together by an investment bank for the purpose of making parallel loans. Apple Inc will lend
$500,000 to the US subsidiary of Toyota Motors for 4 years at 13%. Principal and interest are
payable only at the end of the fourth year with interest compounding annually. Toyota motors
will lend the Japanese subsidiary of Apple Inc 70 million Yen for 4 years at 10%. Again the
principal and interest (annual compounding) are payable at the end. The current exchange
rate is 140 Yen to the $.
However the dollar is expected to decline by 5 Yen to the Dollar per year over the next 4
years.
a. If these expectations prove to be correct what will be the dollar equivalent of principal and
interest payments to Toyota Motors at the end of 4 years .
b. What total dollars will Apple Inc receive at the end of 4 years from the payment of
principal and interest on its loan by the US subsidiary of Toyota Motors .
c. Which party is better off with the parallel loan arrangement. What would happen if the
yen did not change in value.

Question 7:
A German firm buys a call on $ 10,00,000 with a strike of DM 1.60 / $ and a premium of DM
0.03 / $. The interest opportunity cost is 6% per annum and the maturity is 180 days.
(a) What is the break even maturity spot rate beyond with the firm makes a net gain?
(b) Suppose the 6 month forward rate at the time the option was bought was DM 1.62 / $,
What is the range of maturity spot rate for which the option would prove better than the
forward cover? For what range of values would the forward cover be better?

:3: REVISION NOTES – MAY ‘19

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