Political Risk and Currency Derivative Values
Solve the following problem:
Assume that interest rate parity exists. At 10:30 a.m., the media reported news that the Mexican government's political problems were reduced, which reduced the expected volatility of the Mexican peso against the dollar over the next month. However, this news had no effect on the prevailing 1-month interest rates of the U.S. dollar or Mexican peso, or on the expected exchange rate of the Mexican peso in 1 month. The spot rate of the Mexican peso was $.13 as of 10 a.m. and remained at that level all morning.
a. At 10 a.m., Piazza Co. purchased a call option at the money on 1 million Mexican pesos with a December expiration date. At 11:00 a. m., Corradetti Co. purchased a call option at the money on 1 million pesos with a December expiration date. Did Corradetti Co. pay more, less, or the same as Piazza Co. for the options? Briefly explain.
b. Teke Co. purchased futures contracts on 1 million Mexican pesos with a December settlement date at 10 a.m. Malone Co. purchased futures contracts on 1 million Mexican pesos with a December settlement date at 11 a.m. Did Teke Co. pay more, less, or the same as Malone Co. for the futures contracts? Briefly explain.