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# Question 18 By using the future contract: If you buy 50 000 of \$1.9/1, you will get 50 000 in a year time.

If your expectation of the spot rate on expiry in September 2013 is correct at \$2.1/1, you can sell the 50 000 for \$ 105 000 and get profit of 105 000- 1.9 * 50000 = \$10000 which is equivalents 10 000/2.1= 4761.9. If however you are wrong and the spot rate is \$ 1.7/1 in a years time you will lose \$10 000 or \$5882.35 By using the option contract: You can pay a call premium of 50000*0.08= \$4000 for the right to buy sterling at \$1.9/1 in a years time. If sterling is \$2.1/1 in a years time you will exercise your right to buy 50 000 at \$1.9/1 then sell it for \$2.1/1 giving profit of \$10 000 less \$4000 premium a net profit of \$6000 which is equivalent of 6000/2.1 = 2857. If the rate is \$1.7/1 in a years time the speculator will not exercise the option but they will lose the premium of \$4000 which is equivalent to 4000/1.7 = 2352.9 It is difficult to say which the best for speculation, because by using the future contract, the profit/ losses are symmetric. On the other hand, by using the option contract, the upside is large but the downside loss is limit to the \$4000 option premium. At certain exchange rate, the future leads to most profit while the option contract dominates at other exchange rates. The option contract is however useful if you wish to restrict your potential losses Question 19 The appropriate futures prices is given by the equation

F = S*

Where F is future price ( dollar per pound), S is the spot exchange rate (dollars per pound) S = \$1.9/1, rus is the interest rate on the US dollar rus=5%, ruk is the interest rate on the pound ruk=7%, T is the number of days of duration of the contract T= 180, t is the number of day into the contract ;t= 120. T-t is the number of days remaining to delivery of the contract

F= \$1.9/1 * F= \$1.894/1 b, The appropriate arbitrage model for the pricing of the future index is given by the equation = +( *( )* ) Where is the stock index future price at time t with a settlement date T;

is the price of cash stock index at time t; = 6300 is the annualized cost of finance for the period between t and T ; = 6% is the expected average dividend yield on the stocks that make up the cash index during the holding period; = 1.5% So = 6300 + ( 6300* (0.06-0.015)*145/360)= 6412.6 Question 20 The pricing of interest rate future contracts is based on arbitrage conditions. In particular the price of a future interest rate contract is determined by the so-called forward/forward rate, given by :

Z% = ((

-1) * 365/(