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  • MAT2084 AUG2022 Week 2 Workshop Exercises

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    Tan Pei Ting
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    The treasurer of a US corporation wants to hedge £1 million they will receive in 3 months against exchange rate risk. They can use a 3-month forward contract based on the quoted exchange rates. The forward contract will allow the corporation to exchange £1 million for dollars at a fixed rate in 3 months, protecting them against unfavorable exchange rate movements. The bank takes the opposite position and will gain if the exchange rate moves in their favor, losing if it moves against them. The payoffs of the forward contract depend on the exchange rate in 3 months for both parties.

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    The treasurer of a US corporation wants to hedge £1 million they will receive in 3 months against exchange rate risk. They can use a 3-month forward contract based on the quoted exchange rates. The forward contract will allow the corporation to exchange £1 million for dollars at a fixed rate in 3 months, protecting them against unfavorable exchange rate movements. The bank takes the opposite position and will gain if the exchange rate moves in their favor, losing if it moves against them. The payoffs of the forward contract depend on the exchange rate in 3 months for both parties.

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    © All Rights Reserved
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    17 views5 pages

    MAT2084 AUG2022 Week 2 Workshop Exercises

    Uploaded by

    Tan Pei Ting
    The treasurer of a US corporation wants to hedge £1 million they will receive in 3 months against exchange rate risk. They can use a 3-month forward contract based on the quoted exchange rates. The forward contract will allow the corporation to exchange £1 million for dollars at a fixed rate in 3 months, protecting them against unfavorable exchange rate movements. The bank takes the opposite position and will gain if the exchange rate moves in their favor, losing if it moves against them. The payoffs of the forward contract depend on the exchange rate in 3 months for both parties.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    MAT2084 Derivative Securities I B Sc (Hons) in Actuarial Studies

    Exercise
    The treasurer of a US corporation knows that the corporation will receive £1 million in 3 months and
    wants to hedge against exchange rate moves.

    Table 1.4.2: Spot and forward quotes for the USD/GBP exchange rate for the bank
    Bid (buy GBP) Offer (sell GBP)
    Spot 1.4407 1.4411
    1-month forward 1.4408 1.4413
    3-month forward 1.4410 1.4415
    6-month forward 1.4416 1.4422

    (a) Explain how the treasurer might use a forward contract for hedging.
    (b) How much does the US corporation gain or lose if the exchange rate at the end of the contract is
    (i) $1.4400/£;
    (ii) $1.4500/£?
    School of Mathematical Sciences (SMS)
    MAT2084 Derivative Securities I B Sc (Hons) in Actuarial Studies

    Exercise
    The treasurer of a US corporation knows that the corporation will receive £1 million in 3 months and
    wants to hedge against exchange rate moves.

    Table 1.4.2: Spot and forward quotes for the USD/GBP exchange rate for the bank
    Bid (buy GBP) Offer (sell GBP)
    Spot 1.4407 1.4411
    1-month forward 1.4408 1.4413
    3-month forward 1.4410 1.4415
    6-month forward 1.4416 1.4422

    (c) Draw a diagram illustrating how the profit of the US corporation from the forward contract depends
    on the exchange rate at maturity of the contract.
    (d) State the payoff and profit functions of the US corporation from the forward contract.

    School of Mathematical Sciences (SMS)


    MAT2084 Derivative Securities I B Sc (Hons) in Actuarial Studies

    Exercise
    The treasurer of a US corporation knows that the corporation will receive £1 million in 3 months and
    wants to hedge against exchange rate moves.

    Table 1.4.2: Spot and forward quotes for the USD/GBP exchange rate for the bank
    Bid (buy GBP) Offer (sell GBP)
    Spot 1.4407 1.4411
    1-month forward 1.4408 1.4413
    3-month forward 1.4410 1.4415
    6-month forward 1.4416 1.4422

    (e) What is the obligation of the bank with the US corporation under the forward contact?
    (f) How much does the bank gain or lose if the exchange rate at the end of the contract is
    (i) $1.4400/£;
    (ii) $1.4500/£?
    School of Mathematical Sciences (SMS)
    MAT2084 Derivative Securities I B Sc (Hons) in Actuarial Studies

    Exercise
    The treasurer of a US corporation knows that the corporation will receive £1 million in 3 months and
    wants to hedge against exchange rate moves.

    Table 1.4.2: Spot and forward quotes for the USD/GBP exchange rate for the bank
    Bid (buy GBP) Offer (sell GBP)
    Spot 1.4407 1.4411
    1-month forward 1.4408 1.4413
    3-month forward 1.4410 1.4415
    6-month forward 1.4416 1.4422

    (g) Draw a diagram illustrating how the profit of the bank from the forward contract depends on the
    exchange rate at maturity of the contract.
    (h) State the payoff and profit functions of the bank from the forward contract.

    School of Mathematical Sciences (SMS)


    MAT2084 Derivative Securities I B Sc (Hons) in Actuarial Studies

    Exercise
    The treasurer of a US corporation knows that the corporation will receive £1 million in 3 months and
    wants to hedge against exchange rate moves.

    Table 1.4.2: Spot and forward quotes for the USD/GBP exchange rate for the bank
    Bid (buy GBP) Offer (sell GBP)
    Spot 1.4407 1.4411
    1-month forward 1.4408 1.4413
    3-month forward 1.4410 1.4415
    6-month forward 1.4416 1.4422

    (i) What is your conclusion on the payoffs of the forward contract for both the US corporation and the
    bank?

    School of Mathematical Sciences (SMS)

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