1. You have acquired an option to buy Swiss francs at a strike price of $.70 per

Question

1. You have acquired an option to buy Swiss francs at a strike price of $.70 per Swiss franc. (At the time you bought the contract, the spot exchange rate was only $.50 per Swiss franc.) In each of the following three cases, would you choose to exercise the option? Answer either "definitely yes", "definitely no", or "maybe yes; maybe no, to wait to see if the spot exchange value of the Swiss franc goes higher"

a) the current spot exchange rate is $.60 per Swiss franc

b) the current spot exchange rate is $.80 per Swiss franc and the contract is about to expire

c) the current spot exchange rate is $.80 per Swiss franc and the contract still have two months to run

d) Would the option be more or less valuable if the Swiss franc is through to be highly volatile this year?

Explanation / Answer

A foreign currency option is an agreement that gives the option purchaser or buyer the right to buy or sell a fixed amount of foreign exchange, in this case, Swiss francs at a fixed price (the strike price) specified time period.

a) The current spot exchange rate is $.60 per Swiss franc and the strike price is $.70 per Swiss franc. Clearly, this is a loss since buying at $.70 and selling it at $.60 will leave a net loss of $.10 per Swiss franc. If there is some time left in maturity, then wait and watch might prove benefitial. Hence, to wait to see if the spot exchange value of the Swiss franc goes higher

b) The current spot exchange rate is $.80 per Swiss franc and the strike price is $.70 per Swiss franc. Clearly, this is a gain since buying at $.70 and selling it at $.80 will leave a net gain of $.10 per Swiss franc. A definitely yes to this.

c) The current spot exchange rate is $.80 per Swiss franc and the strike price is $.70 per Swiss franc. Clearly, this is a gain since buying at $.70 and selling it at $.80 will leave a net gain of $.10 per Swiss franc. A definitely yes to this.

d) The option be more valuable if the Swiss franc is through to be highly volatile this year since options are designed to protect from market risks and this option has this inbuilt mechanism.

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