PART B QUESTION 17 Suppose that the spot and forward (future) NZD/USD exchange r

Question

PART B QUESTION 17 Suppose that the spot and forward (future) NZD/USD exchange rates (both buy and sell) are as follows: Spot NZD USD 0.7000 90 day forward 1 NZD USD 0.6850 What opportunities are open to the arbitrageur if a 90-day European call option to buy 1 NZD for USD 0.6725 costs USD 0.0105? NOTE: Your arbitrage strategy must include buying or selling this option. Assume: (i) Interest rates (both borrowing and lending) in USD are 0.00% pa. (ii) The 90-day European call option expires on the same day as settlement of the 90-day forward contract. Show any arbitrage opportunity in USD for a full range of possible terminal spot rates at the end of 90 days when the option and the 90 day forward contract is assumed to expire. Ignore any margin requirement or transactions costs (other than the option cost) to exploit any arbitrage strategy (10 marks)

Explanation / Answer

Strategy: Buy Call Option 0.6725 Sell Forward 0.6850 Cost of Option 0.0105 A B C D=A+B+C Price at expiration Payoff onCall Cost of Call Payoff on forward Net Profit 0.6675 $0 -0.0105 0.0175 $0.0070 0.6700 $0 -0.0105 0.0150 $0.0045 0.6725 $0 -0.0105 0.0125 $0.0020 0.6750 0.0025 -0.0105 0.0100 $0.0020 0.6800 0.0075 -0.0105 0.0050 $0.0020 0.6850 0.0125 -0.0105 0.0000 $0.0020 0.6875 0.0150 -0.0105 -0.0025 $0.0020 Payoff on Call: Price at expiration = or < 0.6725, Payoff =0 Price at expiration >0.6725Payoff =(Price at expiration )-0.6725 Payoff on Forward Sell: 0.6850-(Price at expiration)

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.