The Smokin' Cracktuary

04-06-2008, 08:16 PM

I am trying to figure out their use of B-S in the solution part b)

they have 130[FN(d1)-KN(d2)]*exp(-r) K=F=Exchange rate

This has me a bit confused. I see that this essentially means at the money call with strike & initial value = 100.

But why is the exp(-r) outside the brackets?

Ok. It may have just hit me. But I'll run it by you anyway.

For currency options q=foriegn risk-free. Here we are just assuming that equals the domestic risk free rate, hence the strike and the initial value will both be discounted by exp(-r).

When doing this problem I was looking for the foriegn risk free rate, and I (obviously mistakenly) assumed it was the 5.5% that the counterparty could borrow. Mainly due to lack of any other options.

I am not sure why they think it's ok to just assume that the foriegn risk free rate is also 5%.

Another thing that chaps my a$$ about this problem is that the estimate the default probability from the spread this guy must borrow at, which is all well and good accept that if this jerk is from a foreign country, how do we know that borrowing rate spread isn't off his domestic risk-free rate?

Implying that we don't really know what his credit spread is, and therefore cannot estimate his default probability.

I suppose this is just one of those places that you have to go and assume, and be sure to tell the graders that we assume, that the borrowing rate given for this guy is based on domestic rates and/or the foreign country's risk free rate is the same as ours.

Or we could assume that this is a pure financial transaction by two Americans just playing the exchange market, hence the borrowing rate would be domestic. However, we'd still have to assume that the foreign currency's risk free rate is the same 5% as ours.

Which just seems stupid when asking a question about a currency futures contract. How effing hard would it be to just say that, and prevent idiots like me from making stupid assumptions about this guy being from another country and being able to borrow at the risk free rate in his homeland.

Ok. I am done.

Other than that, everything is going well. Thanks for asking.

BTW. I am in my 8th hour of studying today (18th of the weekend). Hopefully that helps explain my cheery disposition.

they have 130[FN(d1)-KN(d2)]*exp(-r) K=F=Exchange rate

This has me a bit confused. I see that this essentially means at the money call with strike & initial value = 100.

But why is the exp(-r) outside the brackets?

Ok. It may have just hit me. But I'll run it by you anyway.

For currency options q=foriegn risk-free. Here we are just assuming that equals the domestic risk free rate, hence the strike and the initial value will both be discounted by exp(-r).

When doing this problem I was looking for the foriegn risk free rate, and I (obviously mistakenly) assumed it was the 5.5% that the counterparty could borrow. Mainly due to lack of any other options.

I am not sure why they think it's ok to just assume that the foriegn risk free rate is also 5%.

Another thing that chaps my a$$ about this problem is that the estimate the default probability from the spread this guy must borrow at, which is all well and good accept that if this jerk is from a foreign country, how do we know that borrowing rate spread isn't off his domestic risk-free rate?

Implying that we don't really know what his credit spread is, and therefore cannot estimate his default probability.

I suppose this is just one of those places that you have to go and assume, and be sure to tell the graders that we assume, that the borrowing rate given for this guy is based on domestic rates and/or the foreign country's risk free rate is the same as ours.

Or we could assume that this is a pure financial transaction by two Americans just playing the exchange market, hence the borrowing rate would be domestic. However, we'd still have to assume that the foreign currency's risk free rate is the same 5% as ours.

Which just seems stupid when asking a question about a currency futures contract. How effing hard would it be to just say that, and prevent idiots like me from making stupid assumptions about this guy being from another country and being able to borrow at the risk free rate in his homeland.

Ok. I am done.

Other than that, everything is going well. Thanks for asking.

BTW. I am in my 8th hour of studying today (18th of the weekend). Hopefully that helps explain my cheery disposition.