Exercise 4:

The current exchange rate is 0.8 USD for 1 AUD. Each year the value of the USD relative to the AUD can either

go up by 25% with probability 25%

stay constant with probability 50% go down by 20% with probability 25%

a) Fill out the following table for the exchange rates and the corresponding probabilities.

Year - Exchange rate - Probability

t=1

t=2

b) We obtain 100 USD in 2 years from now. Calculate the value of the 100 USD in AUD for each of the potential exchange rates.

Year - Exchange rate - Value of 100 USD in AUD

t=2

c) Calculate the variance of the 100 USD payment in AUD.