[ 2009 FRM Sample Exam ] Market risk measurement and management Q25 management, following, contract, currency, interest

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25. Assuming constant interest rates, which of the following American currency option contracts may be exercised prior to maturity of the option contract?

i) Call option on a high interest rate currency.

ii) Call option on a low interest rate currency.

iii) Put option on a high interest rate currency.

iv) Put option on a low interest rate currency.

A. i and iii only

B. i and iv only

C. ii and iii only

D. ii and iv only

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Incorrect. High interest rate currencies are expected to depreciate against the $ and hence it is cheaper to purchase prior to the maturity of the call option contract. Low interest rate currencies will appreciate against the $ and hence profitable to sell prior to the expiry of the put option contract. Hence the put option on high interest rate currencies will not be exercised prior to maturity.

Correct. Both call option on high interest currencies and put option on low interest currencies may be exercised prior to maturity of the contract.

Incorrect. Both call option on low interest currencies and put option on high interest currencies will not be exercised prior to maturity of the contract.

Incorrect. Call option on low interest rate currencies will not be exercised prior to maturity of the contract.

Reference: John Hull, Options, Futures and Other Derivatives (5th edition), chapter 13.

Topic: Market Risk.