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Section I: Multiple Choice (1.5 points each) :
1. Yesterday, you bought a call option on Egyptian Pounds that expires on May 1. This afternoon there is an announcement of a coalition government resolving much uncertainty about the political situation and the government’s fiscal and monetary policy. The financial markets in Egypt have responded with a dramatic decrease in volatility. Assuming that all other variables remain the same; then we expect: _______________.
a) the value of your call option will increase
b) the value of your call option will decrease
c) the value of your call option will remain the same
d) the change in value depends on whether the call option is American style, or European style
e) the change in value depends on whether the option is in the money or out of the money
f) d and e
2. I own a call (put) on Euros. If the value of Euros goes up, then the _________.
a) the value of call options will increase
b) the value of call options will decrease
c) the value of put options will increase
d) the value of put options will decrease
e) it depends on whether the call option is American style, or European style
f) the value of call and put options will both remain the same
g) a and c
h) a and d
i) b and c
j) b and d
3. The spot rate on the pound is $1.80 and the 180-day forward rate is $1.84. The difference between the two rates means that we know for sure that (assume that IRP and FEP hold):
a) nominal interest rates are higher in Britain relative to the US
b) nominal interest rates are lower in Britain relative to the US
c) you will have more wealth by investing in Britain
d) you will have more wealth by investing in the US
e) a and c
f) b and d
4. The annual interest rate in the U.S. is 3.5%, the direct spot quote for Polish Zlotys (zł) are $0.3374/zł and the 1-year forward quote for the zloty is $0.3395/zł. At what Polish interest rate would interest rate parity hold?
5. Alice Inc. imports manufactured goods from Ireland to the U.S. Alice’s revenues are primarily in US dollars and expenses are primarily in Euros. The CEO of Alice is concerned about her currency exposure over the next six months and is considering engaging in an option contract with Euros as the underlying asset (S). Which transaction would you recommend?
a) Buy calls
b) Buy puts
c) Write calls
d) Write puts
e) Options are unable to hedge Euro expenses
6. Suppose that I take all profitable trading opportunities that are available. If I engage in covered interest arbitrage but I do not engage in the carry trade (uncovered interest arbitrage) then I must believe the following statements to be true:
a) The International Fisher Effect does not hold
b) Interest Rate Parity does not hold
c) Forward Expectations Parity does not hold
d) a and b
e) b and c
f) a and c
g) all of the above
h) none of the above
7. Gottfried Hi-Post Co. is a Raleigh based company that is planning on building a hard wood manufacturing site in Brazil. Mr. Gottfried is considering engaging in a currency swap to finance the operations in Brazil. The swap that Gottfried will do will consist of _________.
a) Borrowing in US dollars and swapping for a Brazilian Real loan
b) Borrowing in Brazilian Reals and swapping for a US dollar loan
c) Finding equity investors in Brazil that will swap Reals for dollars to invest in Gottfried Co.
d) Finding equity investors in the US that will be willing to swap US assets for Brazilian assets
e) None of the above
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