Nicole Seaman

Director of FRM Operations
Staff member
Learning objectives: Define and contrast exotic derivatives and plain vanilla derivatives ... Identify and describe the characteristics and payoff structures of the following exotic options: gap, forward start, compound, chooser, barrier, binary, lookback, Asian, exchange, and basket options,


22.27.1. An asset is insured for $100,000 with a deductible of $3,000. In addition, to assess and process a claim, the insurance company will incur a cost of $1,500. Which of the following best describes the exotic option that the insurance company is effectively selling?

a. Forward start put option with strike price, K = $9,700
b. Gap call option with strike price, K1 = $101,500, and trigger price, K2 = $103,000
c. Gap put option with strike price, K1 = $98,500, and trigger price, K2 = $97,000
d. Floating lookup put option with an initial cost of $4,500 and a strike price of $100,000

22.27.2. Consider a binary cash-or-nothing call option that pays $100.00 if the stock is above $100.00 at maturity in three months. The option's underlying non-dividend-paying stock is currently trading at $85.00. The riskfree rate is 4.0% per annum with continuous compounding. We are also told that while S = $85.00 and K = $100.00, N(1) = 0.12350 and N(d2) = 0.100, and the price of a vanilla three-month European call option on this stock is $0.62. Which is nearest to the price of the cash-or-nothing call?

a. $0.62
b. $9.88
c. $10.50
d. $20.38

22.27.3. Suppose a Canadian company has negotiated a contract that includes their expectation to receive 5.0 million euros each month over the next eighteen months, or 90.0 million euros (cumulatively) in total. The Canadian company's treasurer is evaluating exotic options that would minimize their currency risk; she is concerned that the euro might depreciate against the Canadian dollar. The current exchange rate is EURCAD $1.3500.

a. Purchase an Asian average price put with strike price of $1.3XXX EURCAD
b. Purchase an Asian average price call with strike price of $1.3XXX EURCAD
c. Purchase a down-and-in barrier option with strike price of 0.7692 CADEUR
d. Purchase a floating lookback put with strike price of $1.3XXX EURCAD

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