đề thi tài chính quốc tế International Financial Management

Hemant Nahata
Roll No. 08509

Tutorial 3 (Individual Assignment)
August 23, 2009
International Financial Management

1. What is meant by the terminology that an option is in-, at-, or out-of-the-money?
Option is in the money: When the option holder benefits by exercising the option. In a call
option the option holder will benefit when the spot price of the underlying asset is higher than
the exercise price of the underlying asset. Similarly the option holder of a put option will benefit
when the spot price is less than the exercise price of the underlying asset.
Option is at the money: When the spot price of the underlying asset and the exercise price are
equal, then the option holder does not gain anything by exercising the option. So the option
holder may try to sell his option and recover some amount of premium provided that the
premium received exceeds the brokerage amount.
Option is said to be out of money when the option holder does not gain anything by exercising
the option. In case of call option if the Spot price of the underlying asset is less than the exercise
price then the option will not be exercised, similarly the holder of a put option will lapse the
option instead of exercising it when the spot price is higher than the Exercise price.
2. Demonstrate with examples how would you hedge a receivable and payable position using
options. (Use examples out of the examples in slide)
In Ausust 2009, a Carpet exporter from Nepal purchases Raw Wool worth US$ 100,000 from
New Zealand under 90 days USD T/R Loan and sells his carpets for Euro 100,000 to a German
buyer under a 90 days usance L/C. the spot rate on 23rd August is as follows:
NRB rates:
Euro Buying NRs. 110.59 and USD Selling USD 78.25
If he wants to hedge his risk then on the Euro receivables he will have to cover his losses that
may arise due to the depreciation of Euro against Nepali rupees. He will have to buy a forward
put option at a premium so that he locks the rate at which he will receive Nrs. For the Euro
receivables. He buys a Euro call option at strike price of NRs. 109, with a brokerage fees of Rs.

1,500 per 10,000 Euro contract.
Premium paid = (110.59-109) x 100000 = 159000
Brokerage fees for 10 contract @ 1500 = 15,000
Total expense for buying the contract = 174,000
The Exporter has ensured that his Euro receivables will get minimum 108.85
If the sport rate at the time of payment is Rs 105 (below the exercise price of 109) then the
exporter will exercise his call option get the Euro exchanged for the exercise price of Rs. 109
for his Euro receivables.
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If he wants to hedge his risk then on the Dollar receivables he will have to cover his losses that
may arise due to the appreciation of US Dollars against Nepali rupees. He will have to buy a
call option so that he locks the rate at which he will have to pay Nepali Rs. For the settlement of
USD import bills. He buys a Dollar put option at the strike price of 78.50, with a brokerage fees
of Rs. 1000 per USD 10,000 contract.
Premium paid = (78.50-78.25) x 100000 = 25000
Brokerage fees for 10 contract @ 1000 = 10,000
Total expense for buying the contract = 35,000
The Exporter has ensured that his cost for USD payables will get exceed 78.60
If the sport rate at the time of payment is Rs 80 (above the exercise price of 78.50) then the
exporter will exercise his forward put option get the US$ exchanged for the exercise price of
Rs. 78.50 for his USD payables..
In case the options are out of money then they will not be exercised. If the options are in the
money the option will be exercised to that will save the exporter from unexpected losses that
may arise due to foreign exchange fluctuations.
3. A speculator is considering the purchase of five three-month Japanese yen call options with a
striking price of 96 cents per 100 yen. The premium is 1.35 cents per 100 yen. The spot price is

95.28 cents per 100 yen and the 90-day forward rate is 95.71 cents. The speculator believes the
yen will appreciate to $1.00 per 100 yen over the next three months. As the speculator’s
assistant, you have been asked to prepare the following:
a) Diagram the call option.
Given:
Speculator purchases 5 three months contract of Yen call options with striking price of 96
cents per 100 yen.
Each Contract value is assumed to be of 6.25 million Yen
Premium is 1.35 cents per 100 Yen or $0.000135 per yen
Therefore, premium paid per contract is : 0.000135 x 6,250,000 = US$ 843.75
and total premium paid for 5 contracts is : 0.000135 x 6,250,000 x 5 = US$ 4218.75
His buying rate for Yen will not exceed 97.35 cents per 100 yen
Net Gain /Loss on each contract to the speculator at different price levels is as follows:
Spot Price
Profit/Loss

94
-843.75

95
-843.75

96
-843.75

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97
-219

97.35
0

99
1031

100
1656

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101
2281


b) Determine the speculator’s profit if the yen appreciates to $1.00/100 yen.
If the Yen appreciates to $1.00/100 yen then the speculator will gain as follows:
6,250,000 x 5 x (0.010000-0.009735) =$ 8281.25
c) Determine the speculator’s profit if the yen appreciates only to the forward rate.
If the Yen appreciates to the forward rate of 95.71 then he will lose as follows:
6,250,000 x 5 x (0.009571-0.009735) = - $ 5,125
d) Determine the future spot price at which the speculator will only break even.
The speculator will break even at 97.35 cents per 100 Yen.
4. On April 28, you purchased a European Call option of GBP at a strike price of $ 1.4000 for a
premium of $ 0.07. The spot rate at the time was $ 1.4500. The expiry date is October 16. The
amount underlying is GBP 62500.
a) What is the total premium payment?
The Total premium payment is GBP 62,500 x $0.07 = US$ 4,375.00
b) Is the option in-the-money, at-the-money or out-of-the-money?
This is a call option and upon maturity the Spot price is $ 1.45 which is higher than

Strike price, therefore the option is in-the-money.

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c) Does the option have any intrinsic value? If yes, how much? How much is its time
value?
Intrinsic value is the difference between the exercise price of the option and the spot
price of the underlying asset.
Hence the Intrinsic value of the option is $ 1.45-$ 1.40 =$ 0.05
Speculative value (Time value) is the difference between the option premium and the
intrinsic value of the option.
Hence the Time value of the option is $ 0.07-$ 0.05=$ 0.02
d) On expiry suppose the spot rate is USD/GBP = 1.4800. Will you exercise the option?
What is your net gain or loss?
The Spot price is higher than the Exercise price therefore the option is in-the-money and
the option has to be exercised to materialize the gain. The net gain would be
GBP 62,500 x (1.48-1.40) - $4375 = $ 625.
5. You have a payable of EUR 500,000 three months from now. The USD/EUR spot is 0.8700,
three month forward is 0.8825. You decide to purchase a put option on USD vs. EUR at a strike
price of EUR 1.1235 per USD. You have to pay a total premium of $ 7,500.
a) Is the option in-the-money, out-of-the-money or at-the-money with reference to the
current spot rate?
Spot rate = 0.8700 USD/EUR, this is equal to 1.1494 Euro/USD
Striking Price is 1.1235 Euro/USD
Since this is a put option on USD and the spot price is higher than the striking price, the
option is out-of-the-money.
b) At expiry at USD/EUR spot rate is 0.8950. Do you exercise the option?

At expiry if the spot rate is 0.8950. This is equal to 1.1173
This price is lower than the striking price of 1.1235.
For buying Euro 500,000 at spot would cost = $ 447,500
For buying Euro 500,000 at strike price would cost = $ 445,038
Buying Euro at strike price will cost less by $ 2,462 therefore it is better to exercise the
option.
c) Including the cost premium, have you done better than or worse than a forward hedge?
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The cost of buying Euro 500,000 at strike price would cost = $ 445,038 + premium of
US$ 7,500 Total would be US$ 452,538.
The cost of buying Euro at Forward rate of 0.8825 USD/Euro would be 441,250.
Buying Euro under forward contract would save USD 452,538-441,250=$11,588
Since the cost of buying Euro under forward contract is lower than the Option price it is
better to enter in a forward contract than an options contract.
d) In what range must the spot rate at expiry be for the option hedge to be as good or better
than a forward hedge?
The premium is US$ 7500 for Euro 500,000 and the Forward Price is 0.8825
If the spot price is lower than the forward price and covers the premium than the option
hedge is better than the forward hedge. Forward price – premium = 0.8825 -0.0150
=0.8675 USD/EUR
For example if the Spot is 0.8670 then Euro 500,000 can be bought for US$
433,500+7500 = USD 441,000
Whereas the cost of buying Euro at Forward rate of 0.8825 USD/Euro would be 441,250
For the option hedge to be better than a forward hedge the Spot price must be lower than
0.8675 USD/EUR
6. Describe the difference between a swap broker and a swap dealer.

A swap bank may work as a swap dealer or a swap broker.
A swap broker arranges a swap between two counterparties for a fee without taking a risk or a
presuming a position in the swap.
As a dealer the swap bank stands willing to accept either side of the currency swap, and then
later lay it off or match it with one or more counterparty. In this capacity, the swap bank
assumes a position in the swap and therefore assumes certain risks. Here as a dealer the work is
risky, but for this receives cash flows passed through it to compensate it for bearing the risk.

7. What is the necessary condition for a fixed-for-floating interest rate swap to be possible?

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The two parties involved must have the opposite requirement of fixed interest and floating
interest. The borrowing rates of both the parties will not be same, and for a fixed-for-floating
interest rate swap to be possible it is necessary for a quality spread differential to exist.
8. Discuss the basic motivations for a counterparty to enter into a currency swap.
The motivations for parties to enter into currency swaps may be due to the cover the
commercial needs such as converting floating rate liabilities into fixed rate liabilities.
Another reason that motivates swap deals is to cover foreign exchange risks. In a currency
swap, the two payment streams being exchanged are dominated in two different currencies.
Both the parties involved want to lock in long-term exchange rates in the repayment of debt
service obligations denominated in a foreign currency.
In case there is difference in interest rates in different currencies than the lower interest rates
motivates a counter party to finance its debt at a lower interest rate. This also helps to diversify
the funding sources.
9. Discuss the risks confronting an interest rate and currency swap dealer.
The following are the major risks that a swap dealer confronts:

Interest Rate Risk: - This risk refers to the risk of interest rates changing unfavorably before
the swap bank can lay-off on an opposing counterparty the other side of an interest rate swap
entered into with counterparty.
Basis Risk:- this risk refers to a situation in which the floating rates of the two counterparties
are not pegged to the same index.
Exchange Rate Risk: - this risk refers to the swap bank faces from fluctuating exchange rates
during the time it takes for the bank to lay off a swap it undertakes one counterparty with an
opposing counterparty.
Credit Risk: This is one of the major risk faced by the swap bank. It refers to the probability
that a counter party will default. The swap bank that stands between two counterparties is
obliged to honour the contract to the non-defaulting counterparty.
Mismatch Risk: this risk refers to the difficulty of finding an exact opposite match for a swap
the bank has agreed to take. The mismatch may be with respect to the size of the principle
sums the counterparties need, the maturity dates of the individual debt issues, or the debt
service dates.
Sovereign Risk: refers to the probability that a country will impose exchange restrictions on a
currency involved in a swap. This may make it very costly, or perhaps impossible, for a

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counterparty to fulfill its obligation to the dealer. In this event, a provision exists for
terminating the swap, which results in a loss of revenue for the swap bank.
10. Alpha and Beta Companies can borrow at the following rates:

a. Calculate the quality spread differential (QSD).
Fixed rate borrowing
Floating rate borrowing

Alpha
10.5%
LIBO
R

Beta
12%
LIBOR+1%

Quality Spread Differential

Difference
1.5%
1%
0.5%

QSD=0.5%
b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in
their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate
debt.
Alpha Borrows at Fixed rate of 10.5% and lends to Beta at 11.75% fixed rate
Beta Borrows at Libor+1% and lends to Alpha at the same rate.
If this is done, Alpha’s floating-rate all-in-cost is:
= 10.5% + LIBOR+1% - 11.75%
= LIBOR - 0.25%,
i.e. 0.25% savings over its floating-rate debt
Beta’s fixed-rate all-in-cost is:
= (LIBOR+ 1%) + 11.75% - (LIBOR+1%)
= 11.75%,

i.e. 0.25% savings over its fixed-rate debt
By entering a swapping deal Beta saves 0.25% on its Fixed interest cost. Alpha gains 1.25%
on the amount that it lends to beta and finances it by paying 1% extra on the floating rate.
The net gain of Beta is 1.25%-1%=0.25%, they also get their desired floating and fixed rate
debt.

11. Consider the following data:
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Alpha Corporation
Beta Bank
Requirement
Fixed rate USD Funding Fixed rate CHF Funding
Cost of $ Funding
12.5%
11.0%
Cost of CHF Funding
6.5%
6%
Alpha right now has obligation in CHF Funding to CHF Lenders
Beta right now has obligation in USD Funding to USD Lenders
Show how both parties can save on borrowing cost by entering into currency swap.
Assume that the swap bank requires a total gain of 10 bps (0.10 %)
Answer:
The difference between the funding cost of $ and CHF for Alpha Corporation is 6% whereas for
Beta Bank it is 5%, Therefore the Beta Bank has an comparative advantage on funding in
Dollars.

The following swap can be executed so that both the parties win and the swap bank gains 10bps.

CHF @6%
CHF@ 6.5%

Alpha Corp.

Swap Bank
$@11.55%

CHF @6%

$@11.45%

Beta Bank

$ @11%

Alpha Corp Borrows CHF at fixed rate of 6.5% and lends CHF to Swap Bank at 6% , they lose
0.5% in the deal and finance it by borrowing USD @11.55% from Swap Bank thus gaining
0.95% over their fixed USD cost of funding.
Beta Bank Borrows in USD at 11% and lends to Swap Bank at 11.45%. In return borrows CHF
at 6% to finance their fixed rate CHF funding.
If this is done, Alpha Corp.’s USD-rate all-in-cost is:
= CHF 6.5% - CHF 6% + USD 11.55%
= USD 11.55% +0.5%
= USD 12.05%
i.e. 0.45% savings over its USD fixed-rate debt
Beta Bank’s CHF fixed-rate all-in-cost is:
= USD11% + CHF6% - USD 11.45%

= CHF 6%- 0.45%
= CHF 5.55%
i.e. 0.45% savings over its CHF fixed-rate debt
The Swap Bank Borrows USD at 11.45 % from Beta Bank and lends to Alpha Corp at 11.55%
thus earning 0.10% or 10 bps in the swap deal.

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