Suppose the UK investor Adam is planning to import 10,000 worth of steel from the US...

 

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Suppose the UK investor Adam is planning to import 10,000£ worth of steel from the US after 6 months from now to use it as his raw material to produce cars. At present, the exchange rate is 1£/1S. Adam wants to hedge against the risk of the pound depreciating in 6 months. Therefore, he bought a European call option maturing after 6 months by paying 50£ option premium. Then after 6 months, indeed the £ depreciated so that the exchange rate became 1.05£/1$. The interest rate in the US has been 3% consistently throughout the entire 6-month period. (A) What is Adam's payoff as a European call option owner? (Answer in terms of £). Show all your work. [30%] (B) According to the interest parity condition, what can be inferred (i.e. what is the actual % figure) about the UK interest rate throughout the entire 6-month period? Show all your work. [10%] Suppose the UK investor Adam is planning to import 10,000£ worth of steel from the US after 6 months from now to use it as his raw material to produce cars. At present, the exchange rate is 1£/1S. Adam wants to hedge against the risk of the pound depreciating in 6 months. Therefore, he bought a European call option maturing after 6 months by paying 50£ option premium. Then after 6 months, indeed the £ depreciated so that the exchange rate became 1.05£/1$. The interest rate in the US has been 3% consistently throughout the entire 6-month period. (A) What is Adam's payoff as a European call option owner? (Answer in terms of £). Show all your work. [30%] (B) According to the interest parity condition, what can be inferred (i.e. what is the actual % figure) about the UK interest rate throughout the entire 6-month period? Show all your work. [10%]

Answer rating: 100% (QA)

A Adam bought a call option As Adam expected the pound depreciates within 6 months time Spot ... View the full answer