Question: Problem 1: Saguaro Funds

Tony Begay, a currency trader for Chicago-based Saguaro Funds, uses the following futures quotes on the British pound (£) to speculate on the value of the pound.

a. If Tony buys 5 June pound futures, and the spot rate at maturity is $1.3980/£, what is the value of her position?

b. If Tony sells 12 March pound futures, and the spot rate at maturity is $1.4560/£, what is the value of her position?

c. If Tony buys 3 March pound futures, and the spot rate at maturity is $1.4560/£, what is the value of her position?

d. If Tony sells 12 June pound futures, and the spot rate at maturity is $1.3980/£, what is the value of her position?

Interpretation: Buys a futures: Tony buys at the futures price and sells at the ending spot price. She therefore profits when the futures price is less than the ending spot price.

Sells a future: Tony buys at the ending spot price and sells at the futures price. She therefore profits when the futures price is greater than the ending spot price.

Problem 2: Arthur Doyle at Baker Street

Arthur Doyle is a currency trader for Baker Street, a private investment house in London. Baker Street's clients are a collection of wealthy private investors who, with a minimum stake of £250,000 each, wish to speculate on the movement of currencies. The investors expect annual returns in excess of 25%. Although officed in London, all accounts and expectations are based in U.S. dollars.

Arthur is convinced that the British pound will slide significantly -- possibly to $1.3200/£ -- in the coming 30 to 60 days. The current spot rate is $1.4260/£. Arthur wishes to buy a put on pounds which will yield the 25% return expected by his investors. Which of the following put options would you recommend he purchase. Prove your choice is the preferable combination of strike price, maturity, and up-front premium expense.

Issues for Sydney to consider:

1. Because his expectation is for "30 to 60 days" he should confine his choices to the 60 day options to be sure and capture the timing of the exchange rate change. (We have no explicit idea of why he believes this specific timing.)

2. The choice of which strike price is an interesting debate.

* The lower the strike price (1.34 or 1.32), the cheaper the option price.

* The reason they are cheaper is that, statistically speaking, they are increasingly less likely to end up in the money.

* The choice, given that all the options are relatively "cheap," is to pick the strike price which will yield the required return.

* The $1.32 strike price is too far 'down,' given that Sydney only expects the pound to fall to about $1.32.