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(€1.25/£1.00)=(€1.00/$1.60)X($2.00/£1.00)
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Spot Rates Risk-free Rates
S0($/€) $1.60 = €1.00 i$ 3.00%
S0($/£) $2.00 = £1.00 i€ 4.00%
S0(€/£) €1.25 = £1.00 i£ 4.00%
State the composition of the replicating portfolio; your answer should contain "trading
orders" of what to buy and what to sell at time zero.
Buy the present value of 5/9 × £10,000 partly financed by borrowing the pv of 5/9 × €10,000
Consider an option to buy €12,500 for £10,000. In the next period, the euro can
strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more
pounds) or weaken by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Find the dollar value today of a 1-period at-the-money call option on ¥300,000. The spot
exchange rate is ¥100 = $1.00. In the next period, the yen can increase in dollar value by 15
percent or decrease by 15 percent. The risk-free rate in dollars is i$ = 5%; The risk-free rate
in yen is i¥ = 1%.
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Use your results from the last three questions to verify your earlier result for the
value of the call.
C0=(4/9 × €3,125)/1.04=€1,335.47=€6,677.35 − €5,341.88
The value of our option is correct, computed both with risk neutral valuation and with the
replicating portfolio.
Consider an option to buy €12,500 for £10,000. In the next period, the euro can
strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more
pounds) or weaken by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Consider an option to buy €12,500 for £10,000. In the next period, the euro can
strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more
pounds) or weaken by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
State the composition of the replicating portfolio; your answer should contain "trading
orders" of what to buy and what to sell at time zero.
Buy the present value of 5/9 × €12,500 at the spot rate of £1 = €1.25
Borrow the present value of 5/9 × £8,000
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
If the call finishes out-of-the-money what is your replicating portfolio cash flow?
We own 5/9 × £10,000 at the exchange rate of €1/£1 that is worth
€5,555,56 = £5,555.56 × €1/£1
We also owe €5,555,56 to our banker, so the portfolio cash flow = €0
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
If the call finishes in-the-money what is your replicating portfolio cash flow?
We own 5/9 × £10,000 at the exchange rate of €1.5625/£1 that is worth
€8,680.56 = £5,555.56 × €1.5625/£1
We also owe €5,555,56 to our banker, so the portfolio cash flow = €3,125
Consider an option to buy €12,500 for £10,000. In the next period, the euro can
strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more
pounds) or weaken by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
Use your results from the last three questions to verify your earlier result for the
value of the call.
C0=(4/9 × £2,500)/1.04=£1,068.38
£1,068.38=[5/9 × (€12,500/1.04)]×(£1/€1.25)−[5/9 × (£8,000
/1.040)
The value of our option is correct, computed both with rise neutral valuation and with the
replicating portfolio.
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
USING RISK NEUTRAL VALUATION, find the value of the call (in pounds)
C0=(4/9 × £2,500)/1.04=£1,068.38
Consider an option to buy £10,000 for €12,500. In the next period, if the pound
appreciates against the dollar by 37.5 percent then the euro will appreciate against
the dollar by ten percent. On the other hand, the euro could depreciate against the
pound by 20 percent.
Big hint: don't round, keep exchange rates out to at least 4 decimal places.
USING RISK NEUTRAL VALUATION (i.e., the binomial option pricing model) find
the value of the call (in euro).
C0=(4/9 × €3,125)/1.04=€1,335.47