Homework #3 available on I-drive

The third homework assignment is available on the I-drive. It is a 7-point assignment.

I do wish to formally modify the Problem Sets and Writing Assignments portion of the syllabus. Whereas the syllabus states there will be five homework assignments, each worth 5 points, I think we are better off with four assignments, totaling 25 percentage points.

The first assignment was scored out of 7 points. The second assignment was scored out of 5 points. This third assignment will be scored out of 7 points. That will leave the last assignment (due likely the last Friday or Monday of the semester) worth 6 points.

Side comment on my spelling of jewelry: The spelling "jewellery" which I initially wrote, is the acceptable British spelling of the word. However, living in the US and using American Standard English, the spelling "jewelry" is the appropriate spelling. Thanks for helping me out.

Test 2 results and scale

Here are the results of test 2 and the approximate grade scale:

average = 21.73 points out of 30 (72.4 %)
median = 22.5
mode = 28
standard deviation = 4.21 (14.03%)

There's a slight negative skew meaning the number of observations above the mean is greater than the number of observations below the mean.

From your raw score you should use the following as a guide for approximate grade:

A: 25.5 and higher
A/B (on the cusp): 25
B: 22 - 24.5
C: 17.5 - 21.5
D: 15 - 17
F: 14.5 and lower

Answer Key to Study Questions for Test #2 and more

Sorry, no answer key.

Again, finding or making good multiple choice problems is difficult. Some of the ones on that review sheet are not good. Some have mistakes. (e.g., problem 3 is rewritten as problem 11.)

I put out a few additional questions which are better, and the file includes some true-false questions just for review (no T-F questions on the test). The answers provided.

Moreover, I don't think I was clear that you should know about how to use forward markets, especially as a hedge. All discussion of forward foreign exchange markets is fair game.

Blog Update for Test 2

Watch this space.

Heads up: a typo on the homework solutions. For problem 2-A, in calculating the forward premium the denominator had the value $0.050/SFr, but the value should be the current spot rate of $0.50/SFr. The forward premium is still 12%.

Put Options

In case you are tackling problem 5 and are having problems. Here's a quick rundown on put options.

Put options give you the right to sell an asset (in our case, some foreign currency) at a set price (called the strike price). When you buy an option you must pay what is called a premium. Once you own the option you may exercise it at any time until its expiration date. (You may exercise an option any time before the expiration date if it is an American style option. European style options permit you to exercise it only at the expiration date.)

Why buy a put option? In the event you are expected to receive a payment in the foreign currency you may wish to hedge against the appreciation of the dollar. You don't want to wind up with less than you otherwise could. (If the dollar appreciates the dollar price of the foreign currency, say euros, falls and euros are cheaper for Americans. So the euro price of the dollar becomes higher so if you have or are expecting to receive euros, the amount of dollars each euro buys becomes smaller. ) So the put will allow you to sell your euros at a higher price.

You are said to be "in the money" when the spot price is less than the strike price. (You are "at the money" when the strike price and spot price are equal. You are "out of the money" when the spot price is greater than the strike price.)

If you are in the money and you choose to exercise the option your gain is:

(strike price - spot price) x # contracts x contract size

minus

the premium paid.

Why are you in the money when the strike price is greater than the spot price? Because essentially the option gives you the opportunity to buy spot and sell at the strike price. So you are able to buy spot cheap and sell at your higher strike price.

If you did that when the strike price is less than the spot price you would essentially be buying expensive at spot and selling at a lower price at strike. Well, that's just silly. You'd just not exercise it (or let it expire). You're out the premium. But the dollar depreciated instead so your euros will wind up buying more dollars than you thought.

How do I find the premium?

In problem 5 you should look at the table and find the desired strike price. (12200 means $1.2200, that is the strike price, $1.22 per euro.) Once you've found the strike price you want, find the column for puts and the month you want. That number is in terms of cents per euro. (e.g., 1.34 would be $0.0134 in terms of dollars.) So the premium is $0.0134 times the number of euros in the contract (125,000, if I recall) times the number of contracts.