2. Currency options

a. Define call and put options. Discuss how options differ from forward/futures contracts and how firms can purchase options to hedge their exchange rate risks.

b. Consider the following call option on pounds. Both options are exercised at the time of maturity, if feasible. Fill in net profit (or loss) for both purchaser and writer of the option based on the listed possible spot rates of GBP. Draw contingency graph for purchaser and writer below the table (clearly show the break-even rate and other key points on graph).

Call option - premium $0.03, strike price $0.80.

Spot rate

Net profit for purchaser

Net profit for writer

$0.76

0.78

0.80

0.82

0.85

c. Consider the following put option on pounds. Options are exercised at the time of maturity, if feasible. Fill in net profit (or loss) for both purchaser and writer of the option based on the listed possible spot rates of GBP. Draw contingency graph for purchaser and writer below the table (clearly show the break-even rate and other key points on graph).

Put option - premium $0.05, strike price $1.60.

Spot rate

Net profit for purchaser

Net profit for writer

1.55

1.57

1.60

1.62

1.65