FINA 6910 Week 3

Sheet1

00 pounds

Open

High

2

5 June pound futures, and the spot rate at maturity is $1.3980/£, what is the value of her position?

March pound futures, and the spot rate at maturity is $1.4560/£, what is the value of her position?

Values Values Values

£62,500 £62,500 £62,500

June March March June

5 12 3 12

buys sells buys sells

Problem 7.1 Saguaro Funds
Tony Begay, a currency trader for Chicago-based Saguaro Funds, 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, Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	5
	Open
Maturity		High	Low	Settle	Change	Interest
		March	1.4246	1.4268	1.4214	1.4228	0.00	3	1.4700	25,605
		June	1.4164	1.4188	1.4146	1.4162	0.0030	1.4550	809
a. If Tony Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper		buys
b. If Tony		sells		12
c. If Tony buys 3 March pound futures, and the spot rate at maturity is $1.4560/£, what is the value of her position?
d. If Tony sells 12 June pound futures, and the spot rate at maturity is $1.3980/£, what is the value of her position?
a)	b)	c)	d)
Assumptions				Values
Pounds (₤) per futures contract				£62,500
Maturity month
Number of contracts
Did she buy or sell the futures?
Ending spot rate ($/₤)
Pound futures contract, settle price ($/₤)
Spot – Futures
Value of position at maturity ($)
buys: Notional x (Spot – Futures) x contracts
sells: – Notional x (Spot – Futures) x contracts
Interpretation
Buys a futures: Tony buys at the futures price and sells at the ending spot price. She therefore profits when the futures price is less than the ending spot price.
Sells a future: Tony buys at the ending spot price and sells at the futures price. She therefore profits when the futures price is greater than the ending spot price.

Sheet1

00

/£ — in the coming

to

days

. The current spot rate is

/£. Arthur wishes to buy a put on pounds which will yield the 25% return expected by his investors. Which of the following put options would you recommend he purchase. Prove your choice is the preferable combination of strike price, maturity, and up-front premium expense.

/£

/£

/£

30 days

/£

30 days

/£

$1.36/£ 60 days

3/£

$1.34/£ 60 days

0/£

$1.32/£ 60 days

0/£

$1.4260

$1.3200

(US$/£)

$1.36 $1.34 $1.32

30 30 30

$0.00081 $0.00021 $0.00004

Put options on pounds

Strike price (US$/£) $1.36 $1.34 $1.32

Maturity (days) 60 60 60
Premium (US$/£) $0.0033 $0.0015 $0.0006
Put #4 Put #5 Put #6

Net profit Net profit

Strike price

(1.32000) (1.32000)

Problem 7.10 Arthur Doyle at Baker Street

Arthur Doyle is a currency trader for Baker Street, a private investment house in London. Baker Street’s clients are a collection of wealthy private investors who, with a minimum stake of £250,000 each, wish to speculate on the movement of currencies. The investors expect annual returns in excess of 25%. Although officed in London, all accounts and expectations are based in U.S. dollars.

Arthur is convinced that the British pound will slide significantly — possibly to

$1.32

30

60

$1.4260

Strike Price

Maturity

Premium

$1.36

30 days

$0.00081

$1.34

$0.00021

$1.32/£

$0.00004

$0.0033

$0.0015

$0.0006

Assumptions

Values

Current spot rate (US$/£)

Expected endings spot rate in 30 to 60 days (US$/£)

Potential investment principal per person (£)

£250,000.00

Put options on pounds

Put #1

Put #2

Put #3

Strike price

Maturity (days)

Premium (US$/£)

Put #4

Put #5

Put #6

Issues for Sydney to consider:

1. Because his expectation is for “30 to 60 days” he should confine his choices to the 60 day options to be sure and capture

the timing of the exchange rate change. (We have no explicit idea of why he believes this specific timing.)

2. The choice of which strike price is an interesting debate.

* The lower the strike price (1.34 or 1.32), the cheaper the option price.

* The reason they are cheaper is that, statistically speaking, they are increasingly less likely to end up in the money.

* The choice, given that all the options are relatively “cheap,” is to pick the strike price which will yield the required return.

* The $1.32 strike price is too far ‘down,’ given that Sydney only expects the pound to fall to about $1.32.

Net profit

$1.36000

$1.34000

$1.32000

Less expected spot rate

(1.32000)

Less premium

Profit

If Sydney invested an individual’s principal purely

in this specific option, they would purchase an

option of the following notional principal (£):

Expected profit, in total (profit rate x notional):

Initial investment at current spot rate

Return on Investment (ROI)

Risk: They could lose it all (full premium)