Question Details

Currency futures markets are commonly used as a means of capitalizing on shifts 



1. Currency Straddles. Refer to the previous question, but assume that the call and put option
premiums are $.035 per unit and $.025 per unit, respectively. (See Appendix B in this chapter.)
c. Construct a contingency graph for a long pound straddle.
d. Construct a contingency graph for a short pound straddle.

2. Risk of Currency Futures. Currency futures markets are commonly used as a means of capitalizing on shifts in currency values, because the value of a futures contract tends to move in
line with the change in the corresponding currency value. Recently, many currencies appreciated
against the dollar. Most speculators anticipated that these currencies would continue to strengthen
and took large buy positions in currency futures. However, the Fed intervened in the foreign
exchange market by immediately selling foreign currencies in exchange for dollars, causing an
abrupt decline in the values of foreign currencies (as the dollar strengthened). Participants that had
purchased currency futures contracts incurred large losses. One floor broker responded to the
effects of the Fed- intervention by immediately selling 300 futures contracts on British pounds
(with a value of about $30 million). Such actions caused even more panic in the futures market.
a. Explain why the central bank- intervention caused such panic among currency futures traders
with buy positions.

b. Explain why the floor broker- willingness to sell 300 pound futures contracts at the going
market rate aroused such concern. What might this action signal to other brokers?

c. Explain why speculators with short (sell) positions could benefit as a result of the central
bank- intervention.
Future spot
rate
$1.47 $1.62
$1.5 $1.5
-$1.47
$.06
d. Some traders with buy positions may have responded immediately to the central bank-
intervention by selling futures contracts. Why would some speculators with buy positions
leave their positions unchanged or even increase their positions by purchasing more futures
contracts in response to the central bank- intervention?




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