To settle an urgent debt of US $300,000 payable in three months, you have decided to (reluctantly!)
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To settle an urgent debt of US $300,000 payable in three months, you have decided to (reluctantly!) sell your favorite Rolls Royce car for the price of 200,000 British pounds, which you will receive when the car is delivered to the buyer in three months. Because the British pound may lose value relative to the US dollar, you decide to buy appropriate 3-month at-the-money European currency options now to exactly cover the shortfall in case it occurs.
You are given:
(i) The current dollar/pound exchange rate is 1.5.
(ii) The continuously compounded risk-free interest rate in the United States is 4%.
(iii) The continuously compounded risk-free interest rate in the United Kingdom is 8%.
(iv) The future exchange rates of dollar per pound are lognormally distributed with a volatility of 30%.
Calculate the total cost of the currency options in US dollars.
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To determine the total cost of the currency options in US dollars we need to calculate the strike pr...View the full answer
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