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Assignment 1

The document is an assignment for an International Macroeconomics course, consisting of various problems related to the foreign exchange market and currency derivatives. It includes calculations for cotton prices in CHF, expected returns on bonds, profit/loss from investments, arbitrage opportunities, and strategies for managing exchange risk. The assignment is due on November 8 and requires submission in PDF format.

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0% found this document useful (0 votes)
3 views4 pages

Assignment 1

The document is an assignment for an International Macroeconomics course, consisting of various problems related to the foreign exchange market and currency derivatives. It includes calculations for cotton prices in CHF, expected returns on bonds, profit/loss from investments, arbitrage opportunities, and strategies for managing exchange risk. The assignment is due on November 8 and requires submission in PDF format.

Uploaded by

eyilidege2021
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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International Macroeconomics

Assignment 1

THE FOREIGN EXCHANGE MARKET

Problem 1

A Swiss fashion designer is considering importing cotton from three suppliers from three different
countries, who sell them for the following prices:

Supplier Country Price (per 1 kg) Exchange Rate Price in CHF

A USA USD 2.1 USD 1.1/CHF

B India INR 130 INR 81.9/CHF

C Vietnam VND 44,600 VND 24,821.3 /CHF

a. Find the prices of cotton in CHF and add to the table above.
b. Based on the exchange rates in the table above, what should be the exchange rate of
VND per INR?
c. What is the $ price in the US for the Indian cotton (1 kg.)?
d. What might happen to the prices of cotton over time if the three are identical, according
to economic theory?

Problem 2

A European investor bought Singapore government bonds at 1.57 Singapore dollars per euro. She
believes that the EUR will decline to 1.50 SGD per EUR. If a SGD denominated bond during this period
is yielding 2%, what return does she expect in EUR?

International Macroeconomics Page | 1 Dr. Michal Paserman


Problem 3

A year ago, the same European investor invested EUR 3 million in a Chilean airline company. She
bought shares at a then current exchange rate of CLP 880/EUR. The investor bought the shares at an
average price of CLP 56,000 per share.

Yesterday, at the end of one year, the exchange rate was CLP 960/EUR. The investor sold the shares at
a price of CLP 56,200 per share. What is her profit/loss and rate of return?

Problem 4

As a foreign exchange trader, you see the following quotes for Swiss franc (CHF), Canadian dollars
(CAD), and Mexican pesos (MXN):

CAD 1.35/CHF, MXN 22.00/CHF, MXN 16.80/CAD

Is there an arbitrage opportunity here, and if so, how would you exploit it? What would be your
return?

CURRENCY DERIVATIVES

Problem 1
Assume that your Swiss client is scheduled to pay £1,500,000 in two months, for an asset he bought in
the UK.
a. What is your client’s exchange risk?
b. How can your client use put options to mitigate this risk?
c. How can the same thing be achieved with call options? When would you advise the client to
use call options, rather than put options?

Problem 2
Assume that the US announces presidential elections in three months. There is high uncertainty in
financial markets regarding the outcome of the elections and the implications they will have on the
global economy.
Which strategy could be established with options in this situation to protect from the uncertainty?
Demonstrate your answer with a table and a diagram.

Problem 3

Suppose you bought call options on the GBP. You paid CHF 10 for each contract. Each call option
(contract) is on GBP 100. GBP 100 currently sell for CHF 127, and the option has a strike price of CHF
120 per GBP 100.

International Macroeconomics Page | 2 Dr. Michal Paserman


a. Is the option out, at, or in the money?
b. What is the option’s exercise value?
c. What is the option’s time value?
d. Graph the call option payoffs at expiration.
e. Add to the graph the profits from this position.
f. What is your potential profit from this position?
g. What is your potential loss from this position?
h. Determine the profit/loss if the GBP depreciates to CHF 123/ GBP 100. Will you exercise the
option at this exchange rate?
i. Determine the future spot exchange rate at which you will breakeven.

Problem 4

An investor established the following position with call options on the same currency, with the same
expiration date:

option quantity price per contract


Buy C 380 December 2 5640
Write C 400 December 3 3800

When will the investor breakeven? Demonstrate your answer with a table and a diagram.

Problem 5

Several oil-exporting countries and states have been using different ways to hedge their oil income:
Few producers are forward selling their output.
Mexico has been buying put options on oil since 1990.
Texas ran a hedge program from 1992 to 2000, where it used “collars” by buying put options with
exercise price 𝑥1 , while simultaneously writing call options with exercise price 𝑥2 , with the same
expiration date. Assume 𝑥1 < 𝑥2 .

1. For each one of the 3 strategies:


a. Use diagram(s) and a table to describe the payoffs at time T for possible spot price of oil
at T (include oil, the underlying asset itself, in your analysis).
b. How will the premia paid for options at t=0 change your analysis?
c. When will the country/state benefit from this strategy, and when will it lose?

2. Alaska has resolved the problem of volatile oil prices via stabilisation funds that piggy bank
income in the good times to spend it on lean times. What do you think are the advantages
and disadvantages of this strategy, compared with the strategies you analysed in part 1 of this
problem?

International Macroeconomics Page | 3 Dr. Michal Paserman


Problem 6
Buying a “straddle” is equivalent to:
a. Buying two put options, buying the asset and taking a loan.
b. Buying two put options, selling short the asset and buying a bond.
c. Buying two put options, and writing a call option.
d. Writing a put option and buying a call option.

Problem 7
Calculate the value of a 6-months European put option on the USD with a strike price of 0.94.
The current exchange rate is CHF 0.92/USD, the domestic risk-free interest rate in Switzerland is 1%
per annum, the foreign risk-free interest in the US is 2% per annum and the annual standard deviation
of the exchange rate is 8%.

The assignment is due November 8, and should be submitted typed, as a PDF file on Moodle.
(Diagrams can be drawn manually, scanned and added to the solution file).

International Macroeconomics Page | 4 Dr. Michal Paserman

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