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An investment banker is considering the issue of a one-year Australian dollar/U.S. dollar currency-option bond. The currency-option bond is to be issued in A$ (A$1,000),
An investment banker is considering the issue of a one-year Australian dollar/U.S. dollar currency-option bond. The currency-option bond is to be issued in A$ (A$1,000), and the interest and principal are to be repaid in A$ or US$ at the option of the bondholder. The principal repaid would be either A$1,000 or US$549.45. The current spot exchange rate is A$1.82 per US$. The current one-year market interest rates are 8 percent in A$ and 5 percent in US$. A one-year put option on the A$, with a strike price of A$1.82 per US$, is quoted at 2 U.S. cents; this is an option to sell one A$ for 1/US$1.82. a. What should be the fair coupon rate set on this currency-option bond, according to market conditions? b. What is the value of the bond if it is issued at a coupon of 3.4 percent
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