Chapter 12

Question 1

A call option

Answer 1

Option to buy a currency at a set price, (the strike price)

Question 2

A put option

Answer 2

The option to sell a currency

Question 3

The black skulls model of option valuation

Answer 3

Suggest there are two main elements to the value of an option

Intrinsic value – the value that would be generated by exercising the option today. Calculated the difference between the spot price and the strike price.

Time premium – the difference between the total value of the option (the premium) and the intrinsic value

Question 4

Time premium

Driven by…

Answer 4

The standard deviation in the daily value – the more variable the asset price, the more valuable the option.

The time to expiry of the option – the longer the period, the more valuable the option

Risk free interest rate – a high interest rate will lead to a greater value of having a call option, as a call option allows you to buy the underlying asset later and keep your cash deposited early interest

Question 5

Netting and matching

Answer 5

Reduces the amount that needs to be converted

Carried out to reduce the scale of external hedging required

Netting refers to netting off group, receipts and payments.

Matching extends this concept to include third-party such as external suppliers and customers

Question 6

Leading and lagging

Answer 6

Involves an element of speculation regarding the future exchange rate

Involves exchanging when rates are more favourable

Leading indicators look ahead and attempt to predict the future outcomes. Where as lagging indicators look at the past.