I have two questions regarding the exercise:
Why do we not calculate the implied forward rate when valuing the option, similar to what we do with the forward in the first question in B?
Why is wrong to use the following calculation: (102,5-100)*12500000*100 = 3 125 000 000. Then divide by 100 to get per contract = 31 250 000 and then divide by spot rate 102,5 = 304 878.
The correct answer is 3048.78. Why do we need to use 1/100 and 1/102,5?
Anybody with insights here?
They needed CAD risk exposure and seems they took reciprocal JPY/CAD exch.rate to get exposure in CAD in put on JPY.
BTW, I also failed this one.
And why did they not use the implied forward rate?
because for options you don’t have the underlying exposure because you don’t have to execute the trade at the end.
Forwards and Futures require you to execute the trade once you enter into the contract. So you have to account for the interest rate of the underlying exposures
I agree, but in this case it is executed and the payoff should be discounted due to time value right?
Any reason why we do not discount by the risk free rate?
They do not divide by spot rate while calculating option value. They divide by a contract lot, which is usually 100. IMO,it is accidentally put option strike and 100 as option lot same number in this question. They do not discount anything while calculating option value which is for Put simply (X-St,0). The only thing which is tricky in this question is you should take reciprocals to reach CAD exposure and then multiply with NP in JPY.
The only reason we take reciprocal is because Maple Leaf is based in Canada? Any smart way to figure out when to take reciprocal and not?
And, could we have arrived at the same answer without taking reciprocal and instead converted back to CAD in the end?