Question

(a) You have just arrived back from Canada after a very successful business trip. You have managed to sell the designs to a new invention and you will be are paid in 9 months time.   You expect to receive a total of CAD 100,000.

You note that today the spot exchange rate is AUD1.15/CAD and the 9 months forward rate is AUD1.17/CAD. Today, this forward rate is also your expected spot exchange rate in 9 months time. Today, you can also buy a 9 months put option on the CAD with an exercise price of AUD1.1600/CAD for a premium of AUD0.09 per CAD. The 9 month interest rate is 4 % per annum in Australia and 6% per annum in Canada.

REQUIRED:

(i) Calculate the expected AUD premium of selling CAD 100,000 if you choose to hedge by a put option on the CAD. [2 Marks.]

Give your answer to the nearest dollar.

$Answer

(ii) Calculate the future AUD receipt if you decide to hedge using a forward contract. [2 Marks.]

Give your answer to the nearest dollar.

$Answer

(iii) Based on the concept of Interest Rate Parity, what should the forward rate be? [2 Marks.]

Give your answer to 4 decimal places.

Answer AUD/CAD

(b) The USD is trading at a spot price of AUD1.500/AUD. Further, assume that the premium of an American call option with an exercise price of AUD1.51/USD is 12.50 Australian cents and of an American put option with an exercise price of AUD1.5500/USD is 17.10 Australian cents.

REQUIRED:

(i) Calculate the intrinsic values of the call and put options. [1 + 1 = 2 Marks.]

Give your answer in cents. For example, 1.23 means 1.23c, or $0.0123.

PUT: Answer cents

CALL: Answer cents

(ii) Calculate the time value of the call and put options. [1 + 1 = 2 Marks.]

Give your answer in cents. For example, 1.23 means 1.23c, or $0.0123.

PUT: Answer cents

CALL: Answer cents

Answer 1

a

i) Expected AUD premium of Selling CAD using put options = AUD 0.09 .CAD * 100000 CAD =AUD 9000

ii) Using forwards, Future AUD receipt = AUD 1.17/CAD * 100000 CAD = AUD 117000

iii) As per Interest rate parity

9 month forward rate = Spot rate * (1+ interest rate in Australia *9/12) /(1+ interest rate in Canada *9/12)

= 1.15*(1+0.04*9/12)/(1+0.06*9/12)

=1.1335

The forward rate after 9 months should be AU 1.1335/CAD as per Interest rate parity

b) i)

Intrinsic value of call option = max(Spot price - strike price, 0) = max(1.50-1.51,0) = 0 or 0 Cents

Intrinsic value of put option = max(strike price- spot price, 0) = max(1.55-1.50,0) = AUD 0.05 or 5 cents

ii)

Time value of call option = Premium - Intrinsic value = 12.50 cents -0 cents = 12.50 Cents

Time value of put option = Premium - Intrinsic value = 17.10 cents -5 cents = 12.10 Cents