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FOREIGN EXCHANGE

FOREIGN EXCHANGE

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FOREIGN EXCHANGE   

FOREIGN EXCHANGE MARKETS

Name: ……………………………………………………………………………….

Signature: ……………………………………………………………………………….

EXERCICE 1

1- Foreign Exchange Competitive exposure Risk:

1.1 Define Competitive Exposures

1.2 Define hedging techniques for competitive exposures.

1.3 Please describe the limits to the use of financial techniques to hedge competitive risk

EXERCICE 2

Describe the USD currency performance (trade weighted broad)
https://fred.stlouisfed.org/series/DTWEXBGS9

against the rest of the world currencies during the last year in terms of the Holy Trinity. Please note that the graph represents the number of a basket of broad currencies that you need to buy one dollar.

IMPORTANT: It is expected that you answer this question using the following concepts: NER, RER, Inflation Rates in the US and ROW, Net Exports (NX), Savings and Investments in your comment applied to the USD relative to the rest of the world.

EXERCISE 3

The US Company ZYZ has an account receivable in EUR: 10m EUR, to be collected in 1 year.

Please use the following information to calculate the amount of USD that it will receive if it hedges the EUR using forwards, money market hedge and Options. On the option, will you hedge using the call or the put option on the EUR? What alternative provides a better outcome for XYZ?

At maturity of the forward and the option (one year) the USD(EUR exchange rate (the sport) is trading at 1.15 USD/EUR. Will you exercise the option¿ Why? ,

Please describe

IMPORTANT INFORMATION : The quotes given are (USD/EUR) (number of USD to buy one EUR, it is the book convention).

The premium of the option is given in percentage of the amount hedged. The Call option and the PUT option are on the EUR (right to buy or sell the EUR)

Usaboys cost of capital is 5.0%.

Exhibit 1

————————————————————————————-

Spot

1.17

USD/EUR

Forward 1 year

1.185

USD/EUR

Interest Rate
-0,55%

EUR

Interest Rate
0,12%

USD

CALL 1 year Strike 1.185
6.8%

EUR

PUT 1 year Strike 1.19 7.9 % EUR

————————————————————————————–

EXERCISE 4

Given the following USD/AUD quote (the number of AUD to buy one USD),

Calculate the exchange rate appreciation or depreciation under the two scenarios given below. USD/AUD spot today is 0.80. It is important that you describe which currency appreciates or depreciates and the percentage appreciation or depreciation of that currency.

Scenario I: 0.75 USD/AUD

Scenario II: 0.94 USD/AUD

EXERCISE 5

John Scary Always, a market maker at Thanksobihelp! Bank in the US, is managing a FX option book, including some exotic options. John has received the call from one of his biggest institutional clients, who wants to buy a structured note to get $1m exposure to the EUR/USD, (the number of USD that you need to buy one EUR

John trades in the structured note, selling the note (a digital or Binary Option). The Barrier is at 1.21 EUR/USD.

The
Delta exposure for seller of the exotic option
are given in the graph below
(delta exposure
)

(1) Please describe
the Delta of the exotic option and the required hedge the market maker will implement to be delta Neutral (Zero; no directional exposure to the underlying EUR/USD) using hedging instruments like futures that
John will have in his book. There is only
one day to maturity
and the underlying currency pair is trading at 1.205 EUR/USD and hasn’t touched the barrier during the life of the option if the market maker decided to dynamically delta hedge the option Delta using delta one instruments (futures)

(2) Now, once you have answered the previous question, please imagine that the EUR appreciates further against the USD, breaking the barrier above 1.21 EUR/USD.


Please describe the total Delta that John will have in its book now that the option doesn’t exist any more, but the hedging instruments are still in its book


Action? How does John get rid of directional risks once the option does not exist anymore (knock out) and how does it impact the currency market?

image1.emf

13CitiFX Structuring
Market Commentary

M a n a g i n g D i g i t a l R i s k ( D e l t a )

Delta of a 1-month one touch 1.21, payout 1 mio EUR

Delta of a binary 1.21

0

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

140,000,000

160,000,000

1.12 1.14 1.16 1.18 1.20 1.22

1 month to expiry

2 weeks to expiry

1 week to expiry

2 days to expiry

Close to the
trigger at expiry,

the Delta is

extremeNote
the

scale

Delta Hedge: Start by selling cash …until barrier is reached…

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