Three months ago, we took a position in a six-month-forward contract requiring us to deliver €5,400 in exchange for SGD10,000. Our decision was a bet on some political events which in our view would lead to a weaker Euro. Today, the spot exchange rate is €0.57/SGD1, and the risk-free rates of interest on the Euro and the Singapore dollar are respectively 0.35% and 0.15%. The annualized standard deviation of the change in the €/SGD spot exchange rate is equal to 7.5%.

What is the current three-month-forward rate? How should we act in the forward market to lock in the gain already realized, if we believed that the effects on which we were betting have already fully materialized? How should we act in the currency options market if we believed that there is a reasonable chance of a further depreciation of the Euro, but we nevertheless want to guarantee a positive cash flow at least as large as the one that we could lock in today, at the maturity of the contract? What would be the price of the insurance that we would effectively purchase in the latter case?

Answer rating: 100% (QA)

Three months earlier 5400 SGD10000 which implies the exchange rate at the time 540010000 ... View the full answer