PROBLEM SET 5:

FUTURES, OPTIONS & SWAPS

Q 1.

Jamie Rodriguez, a currency trader for Chicago-based Ventosa Investments, uses the following futures quotes on the British pound ( £) to speculate on the
value of the pound.

British Pound Futures, US$/pound (CME) Contract = 62,500 pounds

Open
Maturity Open High Low Settle Change High Interest
March 1.4246 1.4268 1.4214 1.4228 0.0032 1.4700 25,605
June 1.4164 1.4188 1.4146 1.4162 0.0030 1.4550 809

a. If Jaime buys 5 June pound futures, and the spot rate at maturity is $1.3980/ £ , what is the value of her position?
b. If Jamie sells 12 March pound futures, and the spot rate at maturity is $1.4560/ £ , what is the value of her position?
c. If Jamie buys 3 March pound futures, and the spot rate at maturity is $1.4560/ £, what is the value of her position?
d. If Jamie sells 12 June pound futures, and the spot rate at maturity is $1.3980/ £, what is the value of her position?

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Q 2.

Christoph Hoffeman trades currency for Blade Capital of Geneva. Christoph has $10 million to begin with, and he must
state all profits at the end of any speculation in U.S. dollars. The spot rate on the euro is $1.3358/€, while the 30-day
forward rate is $1.3350/€.

a. If Christoph believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be
$1.3600/€ at the end of 30 days, what should he do?

b. If Christoph believes the euro will depreciate in value against the U.S. dollar, so that he expects the spot rate to be
$1.2800/€ at the end of 30 days, what should he do?

a. b.
Assumptions Values Values
Initial investment (funds available) $10,000,000 $10,000,000
Current spot rate (US$/ €) $1.3358 $1.3358
30-day forward rate (US$/ €) $1.3350 $1.3350
Expected spot rate in 30 days (US$/€) $1.3600 $1.2800

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Q 3.

Cachita Haynes works as a currency speculator for Vatic Capital of Los Angeles. Her latest speculative
position is to profit from her expectation that the U.S. dollar will rise significantly against the Japanese
yen. The current spot rate is ¥120.00/$. She must choose between the following 90-day options on the
Japanese yen:

Option Strike Price Premium

Put on yen ¥125/$ $0.00003/S$
Call on yen ¥125/$ $0.00046/S$

a. Should Cachita buy a put on yen or a call on yen?

b. What is Cachita's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Cachita's gross profit and net profit (including premium) if
the spot rate at the end of 90 days is ¥140/$?

Assumptions Values
Current spot rate (Japanese yen/US$) 120.00
in US$/yen $0.00833
Maturity of option (days) 90
Expected ending spot rate in 90 days (yen/$) 140.00
in US$/yen $0.00714

Call on yen Put on yen

Strike price (yen/US$) 125.00 125.00
in US$/yen $0.00800 $0.00800
Premium (US$/yen) $0.00046 $0.00003

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Q 4.

Calandra Panagakos works for CIBC Currency Funds in Toronto. Calandra is something of a contrarian -- as
opposed to most of the forecasts, she believes the Canadian dollar (C$) will appreciate versus the U.S. dollar over
the coming 90 days. The current spot rate is $0.6750/C$. Calandra may choose between the following options on
the Canadian dollar:
Option Strike Price Premium
Put on C$ $0.7000 $0.00003/S$
Call on C$ $0.7000 $0.00049/S$

a. Should Calandra buy a put on Canadian dollars or a call on Canadian dollars?

b. What is Calandra's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Calandra's gross profit and net profit (including premium) if the spot
rate at the end of 90 days is indeed $0.7600?
d. Using your answer from part (a), what is Calandra's gross profit and net profit (including premium) if the spot
rate at the end of 90 days is $0.8250?

Assumptions Values
Current spot rate (US$/Canadian dollar) $0.6750
Days to maturity 90

Option choices on the Canadian dollar: Call option Put option

Strike price (US$/Canadian dollar) $0.7000 $0.7000
Premium (US$/Canadian dollar) $0.00049 $0.0003

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 SWAPS

Q 1. Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would
prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate borrowing. Lluvia is
the more credit-worthy company. They face the following rate structure. Lluvia, with the better credit rating, has
lower borrowing costs in both types of borrowing.
         
Lluvia wants floating rate debt, so it could borrow at LIBOR+1%. However it could borrow fixed at 8% and
swap for floating rate debt. Paraguas wants fixed rate, so it could borrow fixed at 12%. However it could borrow
floating at LIBOR+2% and swap for fixed rate debt. What should they do?

Q 2.

Trident Corporation entered into a three-year cross currency interest rate swap to receive U.S. dollars
and pay Swiss francs. Trident, however, decided to unwind the swap after one year – thereby having
two years left on the settlement costs of unwinding the swap after one year. Repeat the calculations for
unwinding, but assume that the following rates now apply:
                 
Assumptions   Values   Swap Rates   3- year   3-year
bid ask
Notional principal   $ 10,000,000   Original: US 5.56%   5.59%
dollar
Original spot exchange rate, SFr./   1.5000   Original: Swiss 1.93%   2.01%
$ franc
New (1-year later) spot exchange 1.5560            
rate, SFr./$
New fixed US dollar interest   5.20%            

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 New fixed Swiss franc interest   2.20%            

Q 3.

Assume Trident enters into a swap agreement to receive euros and pay Japanese yen, on a notional
principal of €5,000,000. The spot exchange rate at the time of the swap is ¥104/€.
                 
a. Calculate all principal and interest payments, in  
both euros and Swiss francs, for the life of the

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swap agreement.
                 
b. Assume that one year into the swap agreement Trident decides it wishes to unwind the swap
agreement and settle it in euros. Assuming that a two-year fixed rate of interest on the Japanese yen is
now 0.80%, and a two-year fixed rate of interest on the euro is now 3.60%, and the spot rate of
exchange is now ¥114/€, what is the net present value of the swap agreement? Who pays whom what?
                 
                 
Assumptions   Values   Swap   3-   3-
Rates year year
bid ask
Notional principal   €   Euros --   3.24   3.28
5,000,000 € % %
Spot exchange rate, Yen/euro     Japanes   0.56   0.59
104.00 e yen % %
                 

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Falcor is the U.S.-based automotive parts supplier which was spun-off from General Motors in 2000. With annual sales of over $26 b
expanded its markets far beyond the traditional automobile manufacturers in the pursuit of a more diversified sales base.
As part of the general diversification effort, the company wishes to diversify the currency of denomination of its debt
portfolio as well. Assume Falcor enters into a $50 million 7-year cross currency interest rate swap to do just that –
pay euro and receive dollars. Using the data in Exhibit 8.13, solve the following:
                 
a. Calculate all principal and interest payments in both currencies for the life of the swap.
                 
b. Assume that three years later Falcor decides to unwind the swap agreement. If 4-year fixed rates of interest in euros
have now risen to 5.35% and 4-year fixed rate dollars have fallen to 4.40%, and the current spot exchange rate of $1.02/€,
what is the net present value of the swap agreement? Who pays who mwhat?
                 
                 
Swap
Assumptions   Values   Rates 7- year bid 7-year ask    
$
Notional principal   50,000,000   US dollar 5.86% 5.89%    

Spot exchange rate, $/€   1.16   Euros 4.01% 4.05%    

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