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You are offered a chance to by a put or call option from a currency dealer with a strike price of USD 0.8300/CHF with June expiration and premium of USD 0.0050/CHF. Your Magic 8 Ball tells you that the spot exchange rate will reach USD. 8400/CHF sometime between now and June. With USD 100,000 you found, you want to make as much speculative profits as possible using FX options.
A) Carefully derive and draw the profit functions on the two options to help you decide. Be sure to carefully label all axes, strike price, and the break-even point. Which option should you purchase? Exactly which transaction must you carry out and when in order to make the speculative profits?
B) If you used all of the USD 100,000 to speculate on the option you suggested in part A, what are your:
Total Net Profits
Notional Principal
The rate of return on this speculation assuming your Magic 8 Ball is right? (What is your loss if the Magic 8 Ball is wrong?)
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