An American put option to sell a Swiss franc for dollars has a strike price of $0.75 and a time to maturity of one year. The volatility of the Swiss franc is 20%, the dollar interest rate is 4%, the Swiss franc interest rate is 2%, and the current exchange rate is 0.78. Use a three-time-step tree to value the option.

2. A time 0, if you have the insider information that at the maturity the stock price will be 0.87547. Then, which is not the possible sample path? (1 mark)

A. Up-up-down

B. Up-down-up

C. Down-up-up

D. Down-down-up

3. A time 0, if you have the insider information that at the maturity the stock price will be 0.87547. Then, will the option premium at time 0 still be same as if you don't have this information, please choose from the answers below? (1 mark)

A. Yes. Option premium is irrelevant to the private information (about the underlying) that option holder possesses.

B. No. As in that case, the risk neutral probability of the impossible sample paths become zero.

4. If volatility increases, then will the option premium increase or decrease? (1 mark)

A. It depends on the option type call or put.

B. Option premium will increase, because the greater the volatility, the greater the time value of the option.

C. Decrease. Because greater volatility, greater risk, as investors are risk averse, they will value the option less.

D. None of the above

5. Which of the following describes a situation where an American put option on a stock becomes more likely to be exercised early? Hint: early exercise is more likely to happen with reduced time value (1 mark)

A. Volatility decreases

B. Expected dividends increase

C. Interest rates decrease D. All of the above

6. Assume that an exotic option payoff is max[max(St)-K, 0], where t belongs time interval [0, T]. Which of the following statement is false?

A. The option holder can exercise or forfeit the option only at the maturity T.

B. The option cannot be priced using Binomial tree.

C. The option holder can exercise or forfeit the option at any time t.

D. The option payoff is path dependent.