1. Futures are marked to market while forwards are not. Explain.
2. What is meant by an option that is in-, at-, or out-of-the-money?
3. Citigroup sells a call option on euros (contract size is €500,000) at a premium of $0.04 per euro. If the exercise price is $1.34 and the spot price of the euro at expiration is $1.36, what is Citigroup’s profit (loss) on the call option?
4. Graph the seller’s profit or loss for the call option described in #3. What is the break-even spot exchange rate?
5. Magnetronics, Inc., a U.S. company, owes its Taiwanese supplier NT$205 million in three months. The company wishes to hedge its NT$ payable. The current spot rate is NT$1 = US$0.03987, and the three-month forward rate is NT$1 = US$0.04051.
Magnetronics can also borrow/lend U.S. dollars at an annualized interest rate of 12% and Taiwanese dollars at an annualized interest rate of 8%.
What is the U.S. dollar cost for Magnetronics by forward hedge?
What is the U.S. dollar cost by money market hedge? Describe the procedure it would use to get this price.
If the firm wanted to use option hedge, should it buy a call or put on NT$?