Finance calculations and predictions

How much money will Hans have made speculating in the spot market if everything goes as planned?

If everything goes as planned, Hans will earn $102,546.57, resulting in a profit of $2,546.57 or 2.5% after deducting the cost of interest income and opportunity costs.

How long will it take Hans to make a profit if he speculates in the spot market?

Making a profit

According to the first scenario, Hans will be profitable in less than six months.

Why would Hans purchase a call option in Swiss francs?

Hans would buy a Swiss franccall, because she believes that it would appreciate or he will get a profit after that.

When would he exercise the call option? Can he let the option expire without being exercised?

He would exercise the call option when he wants to speculate in the options market, his viewpoint would determine what type of option to buy or sell. He would not exercise his option because he could purchase Frances cheaper on the spot market than via his call option.

What would be his total possible loss from this strategy of buying a call

His total possible lose from this strategy would be limited to the cost of the option, or the premium ($0.0050/CHF)

What is his total possible gain from the strategy of buying a call?

The total possible gain from the strategy of buying callis at $1.

What is the possible price range for this ‘in the money’ call option? Use the graph on slide 7

The possible price range for the buyer of a call option is $0.50.

What is the possible price range for this ‘out of the money’ call option? Use the graph on slide 7.

The possible price range for the buyer ‘out money’ is $0.50.

When is a call option ‘at the money’?

A call is option at the money, when there is limited profit and unlimited lose made.

What would be his total profit (the lot size is CHF62,500) if sometime before

expiration the spot value of the franc is 59.50USD/100 CHF?

Profit = premium-(strike price + sport rate)

0.005-CHF62,500+59.50/100

0.005-62600

=-62599.995.

Why would Hans buy a put?

Hans would buy a put because a put would allow him to have the right to sell the currency at the strike price. The put would bring gain to him.

Questions

1. Explain how the international trade flows should initially adjust in response to the changes in inflation (holding exchange rates constant). Explain how the international capital flows should adjust in response to the changes in interest rates (holding exchange rates constant).

International trade flows are the exchange of goods and services for money between different countries. It is referred to as sales which cross juridical borders. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price levels rises, each unit of currency buys fewer goods and services

2. Using the information provided, will Alamo expect the pound to appreciate or depreciate in the future? Explain.

Because the interest rates are expected to decline, Alamo would assume the capital flows will decrease to the UK. Since the US interest rates are expected to rise, capital flows to the US will increase. However, the inflation rates implies that the US purchase more British goods and will sells less goods to the UK due to the changes in prices in the two countries. Since Alamo believes that capital flows are more important, they believe the pound will depreciate in the future

3. Alamo believes international capital flows shift in response to changing interest rate differentials. Is there any reason why the changing interest rate differentials in this example will not necessarily cause international capital flows to change significantly? Explain.

Because there is upward pressure on the pound some investors may anticipate an appreciation. This may discourage British investors from attempting to capitalize on US higher interest rates. If the uncertainty about future exchange rates discourages British capital flows to US, there would be no reason to anticipate the pound to depreciate

4. Based on your answer to question 2, how would Alamo’s cash flows be affected by the expected exchange rate movements? Explain.

Alamo’s cash flows would be negatively affected because the pounds received by Alamo would convert to a smaller amount of dollars if the pound weakened.

5. Based on your answer to question 4, should Alamo consider hedging its exchange rate risk? If so, explain how it could hedge using forward contracts, futures contracts, and currency options.

No Alamo should not do that because he will continue to lose more cash flow.