Multinational Business Finance, 16e (Eiteman/Stonehill/Moffett)

Chapter 7 Foreign Currency Derivatives: Futures and Options

7.1 Foreign Currency Futures

1) Financial derivatives are powerful tools that can be used by management for purposes of:
A) speculation.
B) hedging.
C) human resource management.
D) A and B above
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

2) A foreign currency ________ contract calls for the future delivery of a standard amount of
foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap
Answer: A
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

3) Which of the following is NOT a contract specification for currency futures trading on an
organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

1
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4) About ________ of all futures contracts are settled by physical delivery of foreign exchange
between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%
Answer: B
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is
called a:
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.
Answer: C
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

6) A speculator in the futures market wishing to lock in a price at which they could ________ a
foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above
Answer: C
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge

7) A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold
Answer: C
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

2
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8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency
futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency
futures market, and his expectations are correct, which of the following strategies would earn
him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the
dollar appreciate to a value of $1.4250/£ at which time he sold the pound futures. If each pound
futures contract is for an amount of £62,500, how much money did Jack gain or lose from his
speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

10) Which of the following statements regarding currency futures contracts and forward
contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for
any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you
like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between
individuals and banks with other banks via telecom linkages.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge

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11) Which of the following is NOT a difference between a currency futures contract and a
forward contract?
A) The futures contract is marked to market daily, whereas the forward contract is only due to be
settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into
each transaction, whereas the forward contract participants are in direct contact setting the
forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas
there is no specific sales commission with a forward contract because banks earn a profit through
the bid-ask spread.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge

12) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. Jasper should ________ at ________ to profit from changing currency values.
A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge

13) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper buys $100,000 worth of yen at today's spot price and sells within the next six
months at ¥128/$, he will earn a profit of:
A) $146.09.
B) $101,460.94.
C) $1460.94.
D) nothing; he will lose money
Answer: C
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

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14) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper buys $100,000 worth of yen at today's spot price her potential gain is ________
and her potential loss is ________.
A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000
Answer: D
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

15) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper's expectations are correct, then he could profit in the forward market by
________ and then ________.
A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question.
D) He could not profit in the forward market.
Answer: B
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

16) Currency futures contracts have become standard fare and trade readily in the world money
centers.
Answer: TRUE
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

17) The major difference between currency futures and forward contracts is that futures contracts
are standardized for ease of trading on an exchange market whereas forward contracts are
specialized and tailored to meet the needs of clients.
Answer: TRUE
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge

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18) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and
selling a forward contract than if he had invested her money in 6-month U.S. Treasury securities
at an annual rate of 2.50%.
Answer: FALSE
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking

19) Why are foreign currency futures contracts more popular with individuals and banks while
foreign currency forwards are more popular with businesses?
Answer: Foreign currency futures are standardized contracts that lend themselves well to
speculation purposes but less so for hedging purposes. The standardized nature of the futures
contract makes it easy to trade futures and to make bets about general changes in the value of
currencies. Forward contracts are better for hedging in that they are tailored to meet the specific
needs of the client, typically a business, and can be quite useful in reducing exchange rate risk.
Banks are involved in the foreign currency futures market in part to offset positions that they
may have taken in the forward markets as dealers.
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge

7.2 Foreign Currency Options

1) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given
amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

6
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2) A foreign currency ________ option gives the holder the right to ________ a foreign
currency, whereas a foreign currency ________ option gives the holder the right to ________ an
option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above
Answer: A
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

3) The price at which an option can be exercised is called the:

A) premium.
B) spot rate.
C) strike price.
D) commission.
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

4) A/An ________ option can be exercised only on its expiration date, whereas a/an ________
option can be exercised anytime between the date of writing up to and including the exercise
date.
A) American; European
B) American; British
C) Asian; American
D) European; American
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

7
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5) A/An ________ option can be exercised only on its expiration date, whereas a/an ________
option can be exercised anytime between the date of writing up to and including the exercise
date.
A) American; European
B) American; British
C) Asian; American
D) European; American
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

6) A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

7) A call option whose exercise price is less than the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.
Answer: A
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

8) An option whose exercise price is equal to the spot rate is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.
Answer: B
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

8
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9) The main advantage(s) of over-the-counter foreign currency options over exchange traded
options is (are):
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above
Answer: D
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

10) As a general statement, it is safe to say that businesses generally use the ________ for
foreign currency option contracts, and individuals and financial institutions typically use the
________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private
Answer: B
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

TABLE 7.1
Use the table to answer following question(s).

April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

11) Refer to Table 7.1. What was the closing price of the British pound on April 18, 2009?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above
Answer: A
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking

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12) Refer to Table 7.1. The exercise price of ________ giving the purchaser the right to sell
pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50
Answer: B
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking

13) Refer to Table 7.1. The May call option on pounds with a strike price of 1440 means:
A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above
Answer: C
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking

14) Dash Brevenshure works for the currency trading unit of ING Bank in London. He
speculates that in the coming months the dollar will rise sharply vs. the pound. What should
Dash do to act on his speculation?
A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

15) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes
your profit if you choose to exercise the option before maturity?
A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$
Answer: D
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
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16) A call option on euros is written with a strike price of $1.30/euro. Which spot price
maximizes your profit if you choose to exercise the option before maturity?
A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro
Answer: D
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking

17) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the
break-even price for the option?
A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.
Answer: B
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking

18) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To
protect yourself against unexpected changes in the dollar/pound exchange rate you should:
A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

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19) The maximum gain for the purchaser of a call option contract is ________ while the
maximum loss is ________.
A) unlimited; the premium paid
B) the premium paid; unlimited
C) unlimited; unlimited
D) unlimited; the value of the underlying asset
Answer: A
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

20) The buyer of a long call option:

A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

21) Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.
Answer: B
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

22) Which of the following is NOT true for the writer of a put option?
A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

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23) The buyer (long) of a put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the strike price of the underlying asset less the
premium paid.
D) all of the above
Answer: D
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

24) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

25) The writer of the option is referred to as the seller, and the buyer of the option is referred to
as the holder.
Answer: TRUE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

26) Foreign currency options are available both over-the-counter and on organized exchanges.
Answer: TRUE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge

27) Most option profits and losses are realized through taking actual delivery of the currency
rather than offsetting contracts.
Answer: FALSE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

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28) Compare and contrast foreign currency options and futures. Identify situations when you
may prefer one vs. the other when speculating on foreign exchange.
Answer: Foreign currency futures are derivative securities that allow the holder to lock in a price
today for another currency at some point in the future. The foreign currency future contract is an
obligation on the part of the parties to fulfill the terms of the contract. Even if prices change in an
unanticipated way, the parties are obligated to fulfill the terms of the contract. The foreign
currency option contract on the other hand is a right not an obligation to purchase/sell a currency
at some point in the future at a price agreed upon today. If prices change in an unexpected
manner, the buyer of the contract is under no obligation to exercise the contract. Option contracts
are better suited to situations where price changes are anticipated, but the direction of the change
is highly uncertain.
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge

7.3 Option Pricing and Valuation

1) Which of the following is NOT a factor in determining the premium price of a currency
option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.
Answer: D
Diff: 1
L.O.: 7.3 Option Pricing and Valuation
Skill: Recognition
AACSB: Application of knowledge

2) The ________ of an option is the value if the option were to be exercised immediately. It is
the option's ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum
Answer: B
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Recognition
AACSB: Application of knowledge

14
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3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call
option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.
Answer: C
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Analytical
AACSB: Analytical thinking

4) The price of an option is always somewhat greater than its intrinsic value, since there is
always some chance that the intrinsic value will rise between the present and the expiration date.
Answer: TRUE
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Conceptual
AACSB: Application of knowledge

5) Define and explain the logic for the time value of an option. Explain the value of the time
value of an option for deep out-of-the money and deep in-the-money options.
Answer: The time value of an option exists because the price of the underlying currency, the
spot rate, can potentially move further and further into the money before the option's expiration.
Time value is the area between the total value of the option and its intrinsic value. An investor
will pay something today for an out-of-the-money option (i.e., zero intrinsic value) on the chance
that the spot rate will move far enough before maturity to move the option in-the-money.
Consequently, the price of an option is always somewhat greater than its intrinsic value, since
there is always some chance — some might say 'hope everlasting' — that the intrinsic value will
rise by the expiration date. For deep out-of-the money and deep in-the-money options the value
of the time value of an option is insignificant since the chances for the option to increase in value
are slim.
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Conceptual
AACSB: Application of knowledge

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7.4 Currency Option Pricing Sensitivity

1) If the spot rate changes from $1.70/£ to $1.71/£ and there is an option with an initial premium
of $0.033/£ and a delta of 0.5, then the new option premium would be:
A) $0.043/£.
B) $0.038/£.
C) $0.005/£.
D) $1.715/£.
Answer: B
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

2) As an option moves further in-the-money, delta moves toward ________.

A) 0
B) -1
C) 1
D) large numbers
Answer: C
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

3) As an option moves further out-of-the-money, delta moves toward ________.

A) 1
B) 0
C) -1
D) large negative numbers
Answer: B
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

4) Option premiums deteriorate at a/an ________ as they approach expiration.

A) increasing rate
B) proportional rate
C) decreasing rate
D) less than proportional rate
Answer: A
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

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5) Volatility is viewed the following ways EXCEPT:
A) historic.
B) forward-looking.
C) implied.
D) spot.
Answer: D
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

6) For a $1.50/£ call option with an initial premium of $0.033/£ and a lambda of 0.4, after an
increase in annual volatility of 1 percent point — for example from 10% to 11% — the new
option premium would be:
A) $0.036/£.
B) $0.037/£.
C) $0.004/£.
D) $1.54/£.
Answer: B
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

7) Traders who believe volatilities will fall significantly in the near-term will:
A) sell futures now.
B) buy options now.
C) sell options now.
D) buy futures now.
Answer: C
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

8) For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an
increase in the U.S. dollar rate from 8% to 9% — the new ATM option premium would be:
A) $0.037/£.
B) $1.55/£.
C) $0.036/£.
D) $0.035/£.
Answer: D
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

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9) For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an
increase in the foreign interest (the pound sterling rate) rate from 8% to 9% — the new option
premium would be:
A) $0.035/£.
B) $1.48/£.
C) $0.031/£.
D) $0.032/£.
Answer: C
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking

10) The Delta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: C
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

11) The Theta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: A
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

12) The Lambda of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: B
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

18
Copyright © 2023 Pearson Education, Inc.
13) The Rho of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: D
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

14) The Phi of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: C
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

15) Which of the following statements is NOT true about currency option pricing sensitivities?
A) The higher the delta, the more likely the option will move in-the-money.
B) Premiums rise with increases in volatility.
C) Premiums are relatively insensitive during the first days.
D) Increases in domestic interest rates cause decreasing call option premiums.
Answer: D
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

16) The time value is asymmetric in value as you move away from the strike price (i.e., the time
value at two cents above the strike price is not necessarily the same as the time value two cents
below the strike price).
Answer: FALSE
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge

19
Copyright © 2023 Pearson Education, Inc.
17) Standard foreign currency options are priced around the forward rate.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

18) As long as the option has time remaining before expiration, the option will possess time the
time value element.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

19) If an American-style option possesses time value on any day up to expiration date, the option
holder would get more by selling it than exercising it.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

20) The value of any option that is currently in-the-money (ITM) is made up entirely of time
value.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge

21) The sensitivity of the option premium to a small change in the spot exchange rate is called
the gamma.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

22) If the rho of the specific option is known, it is easy to determine how the option's value will
change as the spot rate changes.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

20
Copyright © 2023 Pearson Education, Inc.
23) The higher the delta the greater the probability of the option expiring in-the-money.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

24) Option values increase with the length of time to maturity. The expected change in the option
premium from a small change in the time to expiration is termed delta.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

25) The majority of the option premium is lost in the final days prior to expiration.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

26) A trader who is buying options of longer maturities will pay more, and proportionately more,
for the longer maturity options.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

27) Option volatility is defined as the square root of the standard deviation of daily percentage
changes in the underlying exchange rate.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

28) If the exchange rate's volatility is rising, and therefore the risk of the option not being
exercised is decreasing, the option premium would be increasing.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

21
Copyright © 2023 Pearson Education, Inc.
29) The primary problem with volatility is that it is unobservable; it is the only input into the
option pricing formula that is determined subjectively by the trader pricing the option.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

30) Historical volatility is the correct method for the calculation of the option volatility.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

31) Traders by using the historical volatility assume that the immediate future will be the same as
the recent past, and the historical volatility will equal the forward-looking volatility.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

32) A trader who is purchasing a call option on foreign currency should do so before the
domestic interest rate rises.
Answer: TRUE
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

33) The expected change in the option premium from a small change in the domestic interest rate
(home currency) is termed rho.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

34) The expected change in the option premium from a small change in the foreign interest rate
(foreign currency) is termed vega.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge

22
Copyright © 2023 Pearson Education, Inc.
35) List and explain three "Greek" elements and their impact on a call option premium.
Answer: 1) Delta: is the expected change in the option premium for a small change in the spot
rate. The higher the delta, the more likely the option will move in-the-money. 2) Theta: is the
expected change in the option premium for a small change in time to expiration. Premiums are
relatively insensitive until the final 30 or so days. 3) Lambda: is the expected change in the
option premium for a small change in volatility. Premiums rise with increases in volatility. 4)
Rho: Expected change in the option premium for a small change in the domestic interest rate.
Increases in domestic interest rates cause increasing call option premiums. 5) Phi: Expected
change in the option premium for a small change in the foreign interest rate. Increases in foreign
interest rates cause decreasing call option premiums.
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge

23
Copyright © 2023 Pearson Education, Inc.