Q1

Consider the option on currency HKD against the USD:

Current spot rate is HKD7.50 for 1 USD

Risk-free HKD rate of interest is 5% p.a.

Risk-free USD rate of interest is 2% p.a.

Volatility () of the currency returns is 20% p.a.

Maturity of the option is 3 months.

Strike rate of the option is HKD8.00 for 1 USD

The currency options are European in nature Answer the following questions.

(i) How much does it cost to hold (i.e., buy) a call-HKD option? Use the Garman Kohlhagen model.