In March, a derivatives dealer offers you the following quotes for June British pound option contracts (expressed in U.S. dollars per GBP):

a. Assuming each of these contracts specifies the delivery of GBP 31,250 and expires in exactly three months, complete a table similar to the following (expressed in dollars) for a portfolio consisting of the following positions:
(1) Long one 1.44 call
(2) Short one 1.48 call
(3) Long one 1.40 put
(4) Short one 1.44 put

b. Graph the total net profit (i.e., cumulative profit less net initial cost, ignoring time value considerations) relationship using the June USD/GBP rate on the horizontal axis (be sure to label the breakeven point(s)). Also, comment briefly on the nature of the currency speculation represented by this portfolio.
c. If in exactly one month (i.e., in April) the spot USD/GBP rate falls to 1.385 and the effective annual risk-free rates in the United States and England are 5 percent and 7 percent, respectively, calculate the equilibrium price differential that should exist between a long 1.44 call and a short 1.44 put position. (Hint: Consider what sort of forward contract this option combination is equivalent to and treat the British interest rate as a dividendyield.)

  • CreatedDecember 17, 2014
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