1.

An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i = 5%. The bond costs 1,000 today and will return 1,050 at the end of one year without risk. The current exchange rate is 1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S1 ($/) = 1.80 per

S1 ($/) = 1.40 per

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Your banker quotes the euro-zone risk-free rate at i = 5% and the U.S. risk free rate at i_$ = 4%. What is the value of the option?

Select one:

a. $16.54

b. $80.55

c. $76.54

d. $86.54

e. $66.55