financial risk management

MANG 6020 Financial Risk Management
Seminar 3
Question 1
A trader enters into a short forward contract on 100 million yen. The forward exchange rate is
$0.0080 per yen. How much does the trader gain or lose if the exchange rate at the end of the
contract is (a) $0.0074 per yen; (b) $0.0091 per yen?

Solution:

a) The trader sells 100 million yen for $0.0080 per yen when the exchange rate is $0.0074 per
yen. The gain is 100  00006 millions of dollars or $60,000.
The trader sells 100 million yen for $0.0080 per yen when the exchange rate is $0.0091 per yen.
The loss is 100  00011 millions of dollars or $110,000.


Question 2
A one-year long forward contract on a non-dividend-paying stock is entered into when the stock
price is $40 and the risk-free rate of interest is 10% per annum with continuous compounding.

a) What are the forward price and the initial value of the forward contract?
b) Six months later, the price of the stock is $45 and the risk-free interest rate is still 10%. What
are the forward price and the value of the forward contract?

Solution:
rT
The forward price, F0 , is given by equation F0 = S0e

a) as:
F0 = 40e011 = 4421
or $44.21. The initial value of the forward contract is zero.

b) The delivery price K in the contract is $44.21. The value of the contract, f, after six
months is given by equation (5.5) as:
f = 45 − 4421e−0105

= 295
i.e., it is $2.95. The forward price is:
45e0105 = 4731
or $47.31.

Question 3
The current USD/euro exchange rate is 1.4000 dollar per euro. The six month forward exchange
rate is 1.3950. The six month USD interest rate is 1% per annum continuously compounded.