Assume that today's spot exchange rate is $1.20/.

Also assume that every week, the dollar will either appreciate or depreciate against the euro by 2% (note: a 1% appreciation would result in an exchange rate of $1.20/ * 1/(1.01) = $1.188.../). Assume that these are the only two possible things that can happen. For simplicity, you may also assume that you can borrow or lend at a rate of 0%.

Consider a call option on the euro with a strike price of $1.20/ that matures in 1 week.

a.What possible payoffs can it have?

Dollars app: $1.176/E

Long call: payoff= (1.176-1.2) = {0, +} =$0

Dollars depreciate: $1.224/E

Long call: payoff= (1.224-1.2)=$0.024

b.Assume that you long or short a futures contract on the euro at a price of $1.20/ for any maturity. Can you make a portfolio using a futures contract that will mimic the payoffs of the option at every possible outcome? Hint: You will need to borrow or lend in addition to the future.