1) Suppose that you intend to hedge a CHF cash flow that is expected to materialize sometime
within the next three months. You are contemplating whether you should:
a. use a forward hedge by contacting a bank and setting up a forward contract on CHF
that expires in 3 months, or
b. use a futures hedge by trading CHF futures on the futures exchange in Chicago.
What are the factors that will lead you to prefer one versus the other alternative?
(2) Suppose that the current spot exchange rate is S=1.26$/€. You observe the following
American style options:
a. an American put on the Euro with K=1.30$/€, 3 months till expiration that is selling
in the market for P=0.04$/€.
and
b. an American call on the Euro with K=1.20$/€, 3 months till expiration is selling in
the market for C=0.05$/€.
How would you respond to this situation?
(3) Suppose that you expect the US$ value relative to the Euro to remain fairly stable over the
next few months. In your opinion, there is a very low and equal probability of either a
positive ($ appreciation) or negative ($ depreciation) change in the value of the Euro. How
can you devise a trading strategy that is tailored along your convictions? Show in a graph (or
with a detailed explanation) how that strategy will work and explain the potential pitfalls, if
any.
(4) Suppose you decided to speculate in the FX market. You are particularly bullish about some
of the Emerging markets currencies, such as the Brazilian Real, Indian Rupee, and Korean
Won. Describe what are the alternative investment instruments and strategies you would
consider.
(5) The WSJ Dollar index has been on a gradual decline over the past year or so. What are the
determinants of the value of the dollar in the short run and in the long run?
(6) Large US trade deficits have persisted for a long period of time. Provide a brief background
on this issue and your assessment on whether this constitutes a real problem for the U.S.
economy and the long term value of the US dollar.
Part II: Problem solving. Answer all 10 problems. Total points = 70 pts (i.e., 7 pts for each problem)
(1) PSG Inc., a U.K. manufacturer, is expecting an inflow of 18.3 million US-$ within the next four
months. Today’s spot exchange rate is 0.7407 British pounds (£) per US-$. PSG decides to hedge
using options. The £ interest rate is 1.79%. PSG contacts Citicorp which offers the following options
on the US-$:

• American call option on the US-$ with T=3 months, K=0.74 £/$, and price C=0.025 £/$
• American put option on the US-$ with T=3 months, K=0.74 £/$, and price P=0.012 £/$
• American call option on the US-$ with T=6 months, K=0.74 £/$, and price C=0.029 £/$
• American put option on the US-$ with T=6 months, K=0.74 £/$, and price P=0.015 £/$
  Answer the following questions, assuming that these options have no resale value, and ignoring
  transactions costs.
  a) Which option should PSG choose?
  b) Suppose that 5.5 months later PSG receives the 18.3 million US-$ payment. At that time (t=5.5
  months) the spot exchange rate is 0.68 £/$. What should PSG do? How many £ per US-$ will they
  receive net of the expense for the purchase of the option?
  c) Now, suppose that 5.5 months later (i.e., at the time when PSG will receive 18.3 million US-$) the
  spot exchange rate is 0.78 £/$. What should PSG do? How many £ per US-$ will they receive net of
  the expense for the purchase of the option?

(2) Suppose that you observe the following:
The price of a call option on the Euro (€) is 0.055 $/€. The price of a put option on the € is 0.045 $/€.
Both options have 92 days left to expiration and a strike price of 0.85 $/€. The current spot rate is
0.89 $/€. The $-risk free rate is 3.5% and the €-risk free rate is 3.75%.
a) Is there an arbitrage opportunity? Why?
b) Calculate the arbitrage profits and show the arbitrage transactions and corresponding cash flows
at t=0 (now) and at t=T=92 days later.

(3) ABC Inc., a US importer of European products wishes to devise a hedge of a 32 million Thai Bhat
(Bt) outflow, expected in 3 months. ABC’s financial experts suggest that this exposure can be hedged
using different combinations of € (Euro), CHF (Swiss Franc), ¥ (Yen) and £ (British pound) futures
contracts. They presented the following results of their analysis to the CFO:
ΔS$/Bt = 0.03 + 0.95 Δf
$/CHF + 2.55 Δf
$/¥
[t=1.34] [t=7.50] [t=2.73] R2=0.87
ΔS$/Bt = 0.03 + 0.47 Δf
$/€ – 1.55 Δf
$/£
[t=1.31] [t=12.50] [t=1.41] R2=0.93
Upon seeing the above, the CFO got confused and did not know what to do. All he remembered is
that the size of the €, CHF, ¥, and £ futures contracts is 100,000 €, 125,000 CHF, 12,500,000 ¥ and
62,500 £, respectively. Can you help him devise the hedge? How many contracts does ABC need to
buy/sell if its primary goal is to reduce the exposure as much as possible?

Sample Solution

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Psychologists have identified five main personality traits, often called the “Big Five” or the five-trait model. Think about the “Big Five” personality traits we studied in class. Then select a real or fictional character from literature, film, television, or public life. How could the “Big Five” model be used to understand the character’s personality?

In a multi-paragraph essay, explain what is meant by a “personality trait” according to the “Big Five” model, define each of the “Big Five” traits, and describe the character’s personality using the “Big Five” traits. For each trait, be sure to provide evidence from the character’s thoughts, emotions, and behavior. Include details from class materials, readings, and research on personality to support your discussion.

Sample Solution

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