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Options, Futures, and Other Derivatives

John C. Hull

Chapter 17

Optionson stock indices and currencies - all with Video Answers

Educators


Chapter Questions

Problem 1

A portfolio is currently worth $$\$ 10$$ million and has a beta of 1.0 . An index is currently standing at 800 . Explain how a put option on the index with a strike price of 700 can be used to provide portfolio insurance.of 245 ?

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Problem 2

"Once we know how to value options on a stock paying a dividend yield, we know how to value options on stock indices and currencies." Explain this statement.

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Problem 3

A stock index is currently 300 , the dividend yield on the index is $3 \%$ per annum, and the risk-free interest rate is $8 \%$ per annum. What is a lower bound for the price of a sixmonth European call option on the index when the strike price is 290 ?

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04:10

Problem 4

A currency is currently worth $$\$ 0.80$$ and has a volatility of $12 \%$. The domestic and foreign risk-free interest rates are $6 \%$ and $8 \%$, respectively. Use a two-step binomial tree to value (a) a European four-month call option with a strike price of 0.79 and (b) an American four-month call option with the same strike price.

Narayan Hari
Narayan Hari
Numerade Educator

Problem 5

Explain how corporations can use range forward contracts to hedge their foreign exchange risk when they are due to receive a certain amount of a foreign currency in the future.

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Problem 6

Calculate the value of a three-month at-the-money European call option on a stock index when the index is at 250 , the risk-free interest rate is $10 \%$ per annum, the volatility of the index is $18 \%$ per annum, and the dividend yield on the index is $3 \%$ per annum.

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04:10

Problem 7

Calculate the value of an eight-month European put option on a currency with a strike price of 0.50 . The current exchange rate is 0.52 , the volatility of the exchange rate is $12 \%$, the domestic risk-free interest rate is $4 \%$ per annum, and the foreign risk-free interest rate is $8 \%$ per annum.

Narayan Hari
Narayan Hari
Numerade Educator

Problem 8

Show that the formula in equation (17.12) for a put option to sell one unit of currency A for currency B at strike price $K$ gives the same value as equation (17.11) for a call option to buy $K$ units of currency B for currency A at strike price $1 / K$.

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04:10

Problem 10

A foreign currency is currently worth $$\$ 1.50$$. The domestic and foreign risk-free interest rates are $5 \%$ and $9 \%$, respectively. Calculate a lower bound for the value of a six-month call option on the currency with a strike price of $\$ 1.40$ if it is (a) European and (b) American.

Narayan Hari
Narayan Hari
Numerade Educator

Problem 10

Consider a stock index currently standing at 250 . The dividend yield on the index is $4 \%$ per annum, and the risk-free rate is $6 \%$ per annum. A three-month European call option on the index with a strike price of 245 is currently worth $\$ 10$. What is the value of a three-month put option on the index with a strike price

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Problem 11

An index currently stands at 696 and has a volatility of $30 \%$ per annum. The risk-free rate of interest is $7 \%$ per annum and the index provides a dividend yield of $4 \%$ per annum. Calculate the value of a three-month European put with an exercise price of 700 .

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Problem 12

Show that, if $C$ is the price of an American call with exercise price $K$ and maturity $T$ on a stock paying a dividend yield of $q$, and $P$ is the price of an American put on the same stock with the same strike price and exercise date, then
$$
S_0 e^{-q T}-K<C-P<S_0-K e^{-r T},
$$
where $S_0$ is the stock price, $r$ is the risk-free rate, and $r>0$. (Hint: To obtain the first half of the inequality, consider possible values of:

Portfolio A : a European call option plus an amount $K$ invested at the risk-free rate
Portfolio $B$ : an American put option plus $e^{-q T}$ of stock with dividends being reinvested in the stock.
To obtain the second half of the inequality, consider possible values of:
Portfolio $C$ : an American call option plus an amount $K e^{-r T}$ invested at the riskfree rate
Portfolio D : a European put option plus one stock with dividends being reinvested in the stock.)

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04:10

Problem 13

Show that a European call option on a currency has the same price as the corresponding European put option on the currency when the forward price equals the strike price.

Narayan Hari
Narayan Hari
Numerade Educator

Problem 14

Would you expect the volatility of a stock index to be greater or less than the volatility of a typical stock? Explain your answer.

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02:10

Problem 15

Does the cost of portfolio insurance increase or decrease as the beta of a portfolio increases? Explain your answer.

Tristan Wille
Tristan Wille
Numerade Educator
01:08

Problem 16

Suppose that a portfolio is worth $$\$ 60$$ million and a stock index stands at 1,200 . If the value of the portfolio mirrors the value of the index, what options should be purchased to provide protection against the value of the portfolio falling below $$\$ 54$$ million in one year's time?

Kratika Bhadauria
Kratika Bhadauria
Numerade Educator
01:08

Problem 17

Consider again the situation in Problem 17.16. Suppose that the portfolio has a beta of 2.0 , the risk-free interest rate is $5 \%$ per annum, and the dividend yield on both the portfolio and the index is $3 \%$ per annum. What options should be purchased to provide protection against the value of the portfolio falling below $$\$ 54$$ million in one year's time?

Kratika Bhadauria
Kratika Bhadauria
Numerade Educator

Problem 18

An index currently stands at 1,500 . European call and put options with a strike price of 1,400 and time to maturity of six months have market prices of 154.00 and 34.25 , respectively. The six-month risk-free rate is $5 \%$. What is the implied dividend yield?

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Problem 19

A total return index tracks the return, including dividends, on a certain portfolio. Explain how you would value (a) forward contracts and (b) European options on the index.

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Problem 20

What is the put-call parity relationship for European currency options?

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04:06

Problem 21

Prove the results in equations (17.1), (17.2), and (17.3) using the portfolios indicated.

Charles Carter
Charles Carter
Numerade Educator
00:22

Problem 22

Can an option on the yen/euro exchange rate be created from two options, one on the dollar/euro exchange rate, and the other on the dollar/yen exchange rate? Explain your answer.

Jennifer Stoner
Jennifer Stoner
Numerade Educator

Problem 23

The Dow Jones Industrial Average on July 20,2016 , was 18,580 and the price of a September 185 (European) call option on the index was $$\$ 3.35$$. Use the DerivaGem software to calculate the implied volatility of this option. Assume the risk-free rate was $0.7 \%$ and the dividend yield was $2.75 \%$. The option expires on September 16, 2016. Estimate the price of a September 185 put option. What is the volatility implied by the price you estimate for this option? (Note that options are on the Dow Jones index divided by 100.$)$

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Problem 24

A stock index currently stands at 300 and has a volatility of $20 \%$. The risk-free interest rate is $8 \%$ and the dividend yield on the index is $3 \%$. Use a three-step binomial tree to value a six-month put option on the index with a strike price of 300 if it is (a) European and (b) American?

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Problem 25

Suppose that the spot price of the Canadian dollar is U.S. $$\$ 0.95$$ and that the Canadian dollar/U.S. dollar exchange rate has a volatility of $8 \%$ per annum. The risk-free rates of interest in Canada and the United States are $4 \%$ and $5 \%$ per annum, respectively. Calculate the value of a European call option to buy one Canadian dollar for U.S. $$\$0.95$$ in nine months. Use put-call parity to calculate the price of a European put option to sell one Canadian dollar for U.S. $$\$0.95$$ in nine months. What is the price of a call option to buy U.S. $$\$ 0.95$$ with one Canadian dollar in nine months?

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Problem 26

The spot price of an index is 1,000 and the risk-free rate is $4 \%$. The prices of 3 -month European call and put options when the strike price is 950 are 78 and 26. Estimate (a) the dividend yield and (b) the implied volatility.

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Problem 27

Assume that the price of currency A expressed in terms of the price of currency B follows the process $d S=\left(r_{\mathrm{B}}-r_{\mathrm{A}}\right) S d t+\sigma S d z$, where $r_{\mathrm{A}}$ is the risk-free interest rate in currency $\mathrm{A}$ and $r_{\mathrm{B}}$ is the risk-free interest rate in currency $\mathrm{B}$. What is the process followed by the price of currency $\mathrm{B}$ expressed in terms of currency $\mathrm{A}$ ?

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Problem 28

Suppose the USD/euro exchange rate is 1.3000 . The exchange rate volatility is $15 \%$. A U.S. company will receive 1 million euros in three months. The euro and USD riskfree rates are $5 \%$ and $4 \%$, respectively. The company decides to use a range forward contract with the lower strike price equal to 1.2500 .
(a) What should the higher strike price be to create a zero-cost contract?
(b) What position in calls and puts should the company take?
(c) Show that your answer to (a) does not depend on interest rates provided that the interest rate differential between the two currencies, $r-r_f$, remains the same.

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03:04

Problem 29

In Business Snapshot 17.1 , what is the cost of a guarantee that the return on the fund will not be negative over the next 10 years?

MS
Mike Stern
Numerade Educator
01:01

Problem 30

The one-year forward price of the Mexican peso is $$\$ 0.0750$$ per MXN. The U.S. risk-free rate is $1.25 \%$ and the Mexican risk-free rate is $4.5 \%$. The exchange rate volatility is $13 \%$. What are the values of one-year European and American put options with a strike price of $$\$ 0.0800$$.

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator