You are a trader in Brazil at the Bolsa exchange writing both Calls and Puts. Call and Put options are available on the US dollar with a strike of 2.2R/$ for a premia of .40R and .20R respectively. Assume each contract controls $100,000. Be sure to draw the payoff and profit/loss diagrams before answering the questions.

1. Which breakeven point is correct?

a. Call 2.0

b. Put 2.4

c. Call 2.4

d. Put 1.8

e. Put 2.0

2. If at maturity, the spot is 1.9R/$ at maturity, which option is exercised?

a. Put, profit 10,000R

b. Call, payoff -30,000R

c. Call, payoff -10,000R

d. Put, payoff -30,000R

e. None of the above

3. Suppose that the spot is 2.3R/$ at

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Note, treasury rates (risk-free rates) are used to compute the forwards—not your borrowing rate, which embeds your risk-premium (the additional amount the market or bank charges you for having default risk)—alternatively, under the assumption the cost of capital is the same across countries, you could use the ratio of (one plus) the inflation rates. (If neither risk-free nor inflation rates were available, you could use the ratio of your borrowing rates as an approximation of the ratio of the risk-free rates in computing the forward. But there would likely be some error.)

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Suppose that the Real and Chilean Peso (CP) are about 80% (highly) correlated. The current spot, one and two year US dollar futures prices offered at Chile’s exchange are: 600CP/$, 643CP/$, and 687CP/$, respectively. Each contract controls $50,000. Using information from the previous problem:

12. How could you best cross-hedge your Real cash-flows?

a. Buy eight dollar futures contracts maturing each year

b. Sell eight dollar futures contracts maturing each year

c. Buy seven dollar futures contracts maturing each year

d. Sell seven dollar futures contracts maturing each year

e. Buy seven dollar futures