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ADMS 1000 Lecture Notes - Lecture 9: Cisco Systems, Pound Sterling, Spot Contract

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blushweasel304
6 Jul 2018
School
York University
Department
Administrative Studies
Course
ADMS 1000
Professor
Alan Shapiro

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ADMS 1000 Full Course Notes
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Document Summary

At any time, some put options are deep out of the money. By selecting currency options with an exercise price and premium that fits their objectives, cisco and other mncs can increase their value. Individuals may speculate with currency put options based on their expectations of the future movements in a particular currency. For example, speculators who expect that the british pound will depreciate can purchase british pound put options, which will entitle them to sell british pounds at a specified strike price. Some put options are deep out of the money. This means that the prevailing exchange rate is high above the exercise price. These options are cheaper (have a lower premium) because their low price makes it unlikely they will be exercised. Analogously, the exercise price of other put options is currently far above the prevailing exchange rate and so they are much more likely to be exercised; hence these options are more expensive.

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Related Questions

1. Options versus Futures Describe the general differences between a call option and a futures contract.

2. Speculating with Call Options How are call options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a call option?

3. Speculating with Put Options How are put options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a put option?

4. Selling Options Under what conditions would speculators sell a call option? What is the risk to speculators who sell put options?

7. Leverage of Options How can financial institutions with stock portfolios use stock options when they expect stock prices to rise substantially but do not yet have sufficient funds to purchase more stock?

8. Hedging with Put Options Why would a finan- cial institution holding the stock of Hinton Co. consider buying a put option on that stock rather than simply selling it?

9. Call Options on Futures Describe a call option on interest rate futures. How does it differ from purchasing a futures contract?

10. Put Options on Futures Describe a put option on interest rate futures. How does it differ from selling a futures contract?

11. Hedging Interest Rate Risk Assume a savings institution has a large amount of fixed-rate mortgages and obtains most of its funds from short-term deposits. How could it use options on financial futures to hedge its exposure to interest rate movements? Would futures or options on futures be more appropriate if the institution is concerned that interest rates will decline, causing a large number of mortgage prepayments?

14. Speculating with Stock Options The price of Garner stock is $40. There is a call option on Garner stock that is at the money with a premium of $2.00. There is a put option on Garner stock that is at the money with a premium of $1.80. Why would investors consider writing this call option and this put option? Why would some investors consider buying this call option and this put option?

1. Options versus Futures Describe the general differences between a call option and a futures contract.

2. Speculating with Call Options How are call options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a call option?

3. Speculating with Put Options How are put options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a put option?

4. Selling Options Under what conditions would speculators sell a call option? What is the risk to speculators who sell put options?

7. Leverage of Options How can financial institutions with stock portfolios use stock options when they expect stock prices to rise substantially but do not yet have sufficient funds to purchase more stock?

8. Hedging with Put Options Why would a finan- cial institution holding the stock of Hinton Co. consider buying a put option on that stock rather than simply selling it?

9. Call Options on Futures Describe a call option on interest rate futures. How does it differ from purchasing a futures contract?

10. Put Options on Futures Describe a put option on interest rate futures. How does it differ from selling a futures contract?

11. Hedging Interest Rate Risk Assume a savings institution has a large amount of fixed-rate mortgages and obtains most of its funds from short-term deposits. How could it use options on financial futures to hedge its exposure to interest rate movements? Would futures or options on futures be more appropriate if the institution is concerned that interest rates will decline, causing a large number of mortgage prepayments?

14. Speculating with Stock Options The price of Garner stock is $40. There is a call option on Garner stock that is at the money with a premium of $2.00. There is a put option on Garner stock that is at the money with a premium of $1.80. Why would investors consider writing this call option and this put option? Why would some investors consider buying this call option and this put option?

Mega Fund
Mega Fund invests in stocks of US companies. With uncertainty in the world economy and in the US economy in particular, the US stock market has been quite volatile. The
current portfolio value of Mega Fund is $120 million. Brian, the portfolio manager is concerned about the volatility of stock prices and is thinking of obtaining portfolio
insurance. He also would like to diversify his holdings. With the downgrading of bonds issued in Europe, he believes that investing in bonds issued in Europe would be a good
investment and also diversify the fund holdings. Accordingly, he wants to borrow $125 million and invest in bonds of European firms for 5 years. The average yield from these bonds is 10%. However, these bonds are denominated in euro and all cash flows will occur in euros. Thus, Brian is concerned about the exchange rate risk he will be
undertaking if he invests in European bonds. He also would like to hedge the exchange rate risk through a currency swap. He has collected the following information:
On 1 April, S & P 500 Index is at 2,350. On the same day S & P futures are trading at 2,400 and S & P call options with exercise price of 2,400 is trading at 30. S & P put
options with exercise price of 2400 are trading at 60. Futures and options have a contract multiplier of 100. The options are American options.
The exchange rate on 1 April is Euro 1 = USD1.25 and the foreign exchange rate used for the beginning and end of a currency swap is the same. The swap rates are 5% USD
and 5% Euro.

Question 1
Brian would like to insure portfolio value at $120,000,000 on 1 April.
(a) Show how he can accomplish this by using S&P futures and how many futures contracts are needed.

(b) Show how he can accomplish this using S&P options and how options contracts are needed.

(c) Which of these methods is preferable? Explain why.

Question 2
If Brian enters into a currency swap contract,
(a) Explain how this helps Mega Funds from facing currency risk.
(b) Show clearly the initial cash flow, periodic cash flows, and terminal cash flow resulting from the currency swap.

Question 3
Consider the firm you work for, or another firm whose operations you are familiar with. Briefly describe its operations. What type of financial risks does that firm face?
How can you hedge against those risks? What are the constraints in hedging against those risks? Do the costs and benefits of the hedging strategy you recommend justify
hedging? Substantiate your response