Chapter 5

Question 1

What factors affect Currency Call Option Premiums (Three)

Answer 1

• Spot price relative to the strike price (S-X): Higher the spot rate relative to the strike price the higher the option price will be
• Length of time before expiration(T): the longer the time to expiration the higher the option price will be
• Potential variability of currency: the greater the variability of the currency the higher the probability that the spot rate can rise above the strike price

Question 2

How firms use Currency Call Options

Answer 2

• hedge payables
• hedge project bidding to lock in the dollar cost of potential expenses
• hedge target bidding of possible acquisition
• speculate on expectations of future movements in currency

Question 3

Factors affecting Put Option Premiums

Answer 3

• Spot rate relative to the strike price (S-X): the lower the spot rate relative to the strike price the higher the probability that the option will be exercised
• Length of time until expiration: the longer the time to expiration the greater the put option premium
• variability of the currency: the greater the variability the greater the probability that the option may be exercised

Question 4

Conditional Currency Options

Answer 4

A currency option can be structured with a conditional premim meaning that the premium paid for the option is conditioned on the actual movement in the currency’s value over the period of concern