A currency has a current worth of 1.1131 and its volatility is 15%. Assume that the domestic risk-free rate is 3% and the foreign risk-free rate is 4%. (a) Apply the two-step binomial option pricing model to price an American 3-month call option whose strike price is 1.0500. (10 marks) (b) Apply the Black-Scholes model to price a European 3-month put option with a strike price of 1.0500. (10 marks) (c) Appraise the use of currency options to hedge currency risk.

(10 marks) Use continuous compounding to answer the question.