# Credit risk on put options

Finquiz Essay type Exam 1

The company has a long 100 \$ put options with expiration in six months at a strike price of \$100/€ and a contract size of 9.5mill. The current rates is 101.5/€

Question:

Calculate the amount at risk from a credit loss on the long MXN put option contract. Determine which party bears the credit risk

All credit risk on options is on the log side of the contract (**I understand and I am aware of this)

If rates remain unchanged then risk =

(1/100)-(1/101.5)=0.000244*\$9.5 mill * 100 contracts = EUR 1,403,941

Or EUR 14,040 per contract

I have absolutely lost on the calculation, not understood a bit.

Thank you

they gave MXN/Euro quotes.

which means 1 Euro = 100 MXN Strike,1 1 Euro = 101.5 MXN after (Spot)

Contract is 9.5 Mill MXN.

(All the US are MXN actually).

you need EURO/MXN quotes to get the answer in EURO.

Strike - Spot = 1/100 - 1/101.5 in EUR/MXN

Is there a reason you have to calculate the answer in EUR when the contract size is quoted as \$9.5mn?

I think the \$ is a mistake and should have been MXN instead.

One additional question. The Put and or Call part of the option always refers to the base currency, correct? Since he is long the put option to sell €, isn’t the option out of the money? It is more attractive to sell € at a \$101.5 spot rate rather than \$100 strike. I don’t see how it would have credit risk if it is out of the money (unless the credit risk is the option premium).

In addition to my above question. Isn’t the credit risk (or potential credit risk if it is a European option), just the premium of the option? Not the payout calculation in the equation above?

CFAI pg. 179-181 Volume 5 states that the credit risk of an option is its current value (premium).

kalton corporation has two large derivatives positions with london securities house. the first position is a long forward currency contract to buy pounds at €1.45. the current exchange rste is €1.4/£…

which party is bearing the credit risk?

i am struggling with which way to go when it comes to exchange rate…cpk let us know the trick…

If you are long then you are hoping that the pounds (Base) appreciates with respect to the euro (Price).

Exercise is 1.45 Euros / Pounds and Spot is 1.4, which means that the Euro appreciated and the pounds depreciated since you have to pay less euros to get 1 pound. So you lost your bet; thus you owe the counterparty a payment; therefore, the counterparty bears the credit risk.

Correct?

correct (thinking out loud)

how did u figure £ is the base - is it based on how it is quoted? - let me understand - you take the quote lets say quote is 58inr/; foward 60inr/; im long inr; so as the bank owes me 2inr, i am bearing the credit risk?

i want to buy £ > enter into forward to buy at 1.45€, quote is 1.4€ > i pay more than spot > i owe the bank ctpy .05€, so the ctpy bears the credit risk

(tol end)

put the long currency in denominator, the apply spot - forward > positive - long bears credit risk

can anyone reaffirm?

Ofcourse its based on how it is quoted unless they specify but i believe its always the case with P/B.

if you enter a forward contract at 1.45 dollars / euros … it means you are hoping that the euro (base) appreciates w.r.t the dollars and thus, get more dollars in return for 1 euro. so if the rate goes up as in 1.47 it means that more dollars should be paid for 1 euro. thus … you should get a return for your positive and expect a payment but what if the counterparty defaults? therefore, you are bearing the credit risk since there’s a chance that the counterparty default on his obligation.

thx bilal

mostly welcomed . best of luck everyone…

and why that would mean you answer in Euros?