You Have Written a Call Option on £10,000 with a Strike

question 47

Multiple Choice

You have written a call option on £10,000 with a strike price of $20,000.The current exchange rate is $2.00/£1.00 and in the next period the exchange rate can increase to $4.00/£1.00 or decrease to $1.00/€1.00 .The current interest rates are i_$ = 3% and are i_£ = 2%.Find the hedge ratio and use it to create a position in the underlying asset that will hedge your option position.

• A)Enter into a short position in a futures contract on £6,666.67
• B)Lend the present value of £6,666.67 today at i_£ = 2%
• C)Enter into a long position in a futures contract on £6,666.67
• D)Lending the present value of £6,666.67 today at i_£ = 2% or entering into a long position in a futures contract on £6,666.67 would both work.

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Definitions:

Money Market Instruments

Short-term financial instruments that are highly liquid and designed for cash management by investors, including treasury bills, commercial paper, and certificates of deposit.

Government Bond

Securities issued by governments to finance public expenditure, typically with a promise of future repayment and interest payments.

State Income Taxes

Taxes levied by individual states on the income of residents and businesses within their jurisdiction.

CDs

Short for Compact Discs, a digital optical disc data storage format used to store music, data, or software.