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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

Under put-call parity logic for currency options, which factor increases the premium of both a currency call option and a currency put option, all else equal?

Higher volatility of the exchange rate raises the premium on both calls and puts. The buyer's loss is limited to the premium while gains are unlimited or large, so greater uncertainty increases option value in both directions, unlike changes in strike or interest rates.

  1. AA higher volatility of the exchange rateCorrect
  2. BA longer time to expiry combined with a deeper out-of-the-money strike only for puts
  3. CA higher domestic interest rate
  4. DA lower strike price

Explanation

Higher volatility raises the chance of large favourable moves while losses are limited to the premium, so it increases both call and put values. A lower strike raises the call value but lowers the put value. Interest rate differentials affect calls and puts in opposite directions.

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