Problem 1 (10 points) Assume that you use Purchasing Power Parity (PPP) to forecast exchange rates You expect that inflation in France the next year will be 1 0 , and inflation in the US will be 2 Assume that you are considering the purchase of five one year euro call options from PHLX with a strike price of $1 08 The premium is 0 5 cents per Today the spot rate of the euro is $1 06 The one year forward rate is $1 07 1 Based on your PPP analysis, what will be your expected spot exchange of $ in one year 2 Graph the call option cash flow schedule at maturity Mark clearly where will be option's break even point 3 Determine your expected profit (or loss) if the euro appreciates to your expected future spot rate 4 Determine your expected profit (or loss) if the euro appreciates to the forward rate (Note One PHLX euro option contract covers 10,000 For simplicity, ignore the time value of money)

The Answer is in the image, click to view ...

Question: Problem 1 (10 points): Assume that you use Purchasing Power Parity (PPP) to forecast exchange rates. You expect that inflation in France the next year

Problem 1 (10 points):

Assume that you use Purchasing Power Parity (PPP) to forecast exchange rates. You expect that inflation in France the next year will be -1.0%, and inflation in the US will be +2%. Assume that you are considering the purchase of five one-year euro call options from PHLX with a strike price of $1.08/. The premium is 0.5 cents per . Today the spot rate of the euro is $1.06/. The one-year forward rate is $1.07/.

1. Based on your PPP analysis, what will be your expected spot exchange of $/ in one year?
2. Graph the call option cash flow schedule at maturity. Mark clearly where will be option's break-even point.
3. Determine your expected profit (or loss) if the euro appreciates to your expected future spot rate.
4. Determine your expected profit (or loss) if the euro appreciates to the forward rate.

(Note: One PHLX euro option contract covers 10,000. For simplicity, ignore the time value of money)

Step by Step Solution

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock blur-text-image

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Students Have Also Explored These Related Finance Questions!

1. Assume that you can borrow EUR 1,000,000 or USD 1,000,000. Assume that you use Purchasing Power Parity (PPP) to forecast exchange rates. You expect that inflation in France the next year will be...

Assume that you use Purchasing Power Parity (PPP) to forecast exchange rates. Suppose you expect that inflation in the UK the next year will be 1.0%, and inflation in the US will be 5.0%. Assume that...

In chapter 3, Monetary Approach, we have derived the theory of Purchasing Power Parity (PPP) that links exchange rates to the relative prices of a basket of goods. In Sample Question 5, we discussed...

Assume Switzerland has a one-year interest rate of 3% and that of Ghana is 25%. If the International Fisher Effect (IFE) holds, what would your forecast of the price of Swiss franc in cedis in one...

Purchasing Power Parity theory posits that exchange rates adjust to inflation differences. Annual price inflation for the next four years in Norway is forecast at 3.0% 3.2% 2.7% 2.8% Annual price...

Question 1 (a) Assume that the spot exchange rate of the South African Rand is 1.73. How will this spot rate adjust according to Purchasing Power Parity (PPP) if South Africa experiences an inflation...

Purchasing Power Parity theory posits that exchange rates adjust to inflation differences. Annual price inflation for the next four years in Norway is forecast at 3.0% 3.2% 2.7% 2.8% Annual price...

1. Suppose that the economy of Loserville has the following distribution of income: first quintile 10% of aggregate income second quintile 10% of aggregate income third quintile 15% of aggregate...

Assume that you believe purchasing power parity (PPP) exists. You expect that inflation in Canada during the next year will be 4 percent and inflation in the United States will be 9 percent. Today...

The Boxwood Company sells blankets for $ 32.00 each. The following was taken from the inventory records during May. The company had no beginning inventory on May 1. Date Blankets Units Cost May 03...

The Manager of Toyosu Express is facing the following problems: - The average dining time is more than 100 minutes during lunch hours, leading to a low turnover of tables. It is observed that a high...

Problem 1 7 - 4 9 ( LO 1 7 - 2 ) ( Static ) Which of the following items is not a temporary book tax basis difference? Multiple Choice Warranty reserve accruals Accelerated depreciation Capitalized...

Please solve in excel, thank you! No other information needed, this is the entire question :) JL.51 Carl's Custom Cans produces small containers which are purchased by candy and snack food producers....

2. In this chapter, the reader should reflect on the following concepts : Thomas theorem, premise of action, utterance and mental constructions.

11. Based on the following rules regarding the confidence we have in information in a communication context, find examples from your everyday life where the rules have relevance: (a) The spatial rule...

2. Describe a situation from your own everyday life where it is clear that the situation in its consequence becomes the way you define it.