FRM Part I · FRM Exam Part I · Exotic Options
A corporate treasurer with a foreign currency payable wants cheaper protection than a vanilla call and accepts losing the protection if the currency rises sharply. Which instrument fits?
An up-and-out call on the foreign currency fits. A payer of foreign currency needs call protection against a rise, and the knock-out at a high level cuts the premium while removing protection if the currency rises sharply to the barrier.
- AAn up-and-out call on the foreign currencyCorrect
- BA down-and-out call on the foreign currency
- CAn up-and-in put on the foreign currency
- DA vanilla put on the foreign currency
Explanation
The payer of foreign currency is hurt by a rise in the currency, so needs a call. Protection lost if the currency rises sharply is an up-and-out feature, which lowers the premium. A down-and-out call would lose protection when the currency falls, which is not the scenario described.
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