Consider an option to buy $10,000$ for $12,500.$ In the next period, if the pound appreciates against the dollar by $37\mathrm{.}5$ percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by $20$ percent.

Big hint: don't round, keep exchange rates out to at least $4$ decimal places.

Spot Rates Risk$-$free Rates

S$0($$$/)$ $$1\mathrm{.}60=1\mathrm{.}00$ i$ $3\mathrm{.}00\%$

S$0($$$/)$ $$2\mathrm{.}00=1\mathrm{.}00$ i$4\mathrm{.}00\%$

S$0(/)1\mathrm{.}25=1\mathrm{.}00$ i$4\mathrm{.}00\%$

a$.$ State the composition of the replicating portfolio; your answer should contain "trading orders" of what to buy and what to sell at time zero.

b$.$ Calculate the Hedge Ratio