Question 2. Binomial Model and Option Pricing (14 marks) The shares of XYZ Inc. are currently selling for $120 per share. The shares are expected to go up by 10 percent or down by 5 percent in each of the following two months (Month 1 and Month 2). XYZ Inc. is also expected to pay a dividend yield of 2 percent at the end of Month 1. The risk-free rate is 0.5 percent per month. a. What is the value of an American call option on XYZ shares, with an exercise price of $125 and two months to expiration? Use the binomial model to obtain the answer. (12 marks) b. Draw a binomial tree diagram for this American call option, showing the share price, call price, and whether the call should be exercised at each state during the next two months. (2 marks) Question 3. Currency Option Pricing with Binomial Model (10 marks) On January 11 , the spot exchange rate for the U.S. dollar is $0.70 per Canadian dollar. In one year's time, the Canadian dollar is expected to appreciate by 20 percent or depreciate by 15 percent. We have a European put option on U.S. dollars expiring in one year, with an exercise price of 1.39 CND\$/US\$, that is currently selling for a price of $2.93. Each put option gives the holder the right to sell 10,000 U.S. dollars. The current one-year Canadian Treasury Bill rate is 2 percent, while the one-year U.S. Treasury Bill rate is 3 percent, both compounded annually. Treat the Canadian dollar as the domestic currency. a. What is the estimated value of this put option by using the binomial model? (5 marks) b. Calculate the estimated value of this put option for U.S. T-Bill rates of 0%,1%,2%, 4%,5%, and 6%. Plot these values in a graph (by hand or using Excel), with put option values on the y-axis and U.S. T-bill rates on the x-axis. What can we conclude about the relationship between foreign interest rates and foreign currency put option values? (2.5 marks) c. Calculate the estimated value of this put option for Canadian T-Bill rates of 0%,1%, 2%,4%,5%, and 6%. Plot these values in a graph (by hand or using Excel), with put option values on the y-axis and Canadian T-bill rates on the x-axis. What can we conclude about the relationship between domestic interest rates and foreign currency Question 2. Binomial Model and Option Pricing (14 marks) The shares of XYZ Inc. are currently selling for $120 per share. The shares are expected to go up by 10 percent or down by 5 percent in each of the following two months (Month 1 and Month 2). XYZ Inc. is also expected to pay a dividend yield of 2 percent at the end of Month 1. The risk-free rate is 0.5 percent per month. a. What is the value of an American call option on XYZ shares, with an exercise price of $125 and two months to expiration? Use the binomial model to obtain the answer. (12 marks) b. Draw a binomial tree diagram for this American call option, showing the share price, call price, and whether the call should be exercised at each state during the next two months. (2 marks) Question 3. Currency Option Pricing with Binomial Model (10 marks) On January 11 , the spot exchange rate for the U.S. dollar is $0.70 per Canadian dollar. In one year's time, the Canadian dollar is expected to appreciate by 20 percent or depreciate by 15 percent. We have a European put option on U.S. dollars expiring in one year, with an exercise price of 1.39 CND\$/US\$, that is currently selling for a price of $2.93. Each put option gives the holder the right to sell 10,000 U.S. dollars. The current one-year Canadian Treasury Bill rate is 2 percent, while the one-year U.S. Treasury Bill rate is 3 percent, both compounded annually. Treat the Canadian dollar as the domestic currency. a. What is the estimated value of this put option by using the binomial model? (5 marks) b. Calculate the estimated value of this put option for U.S. T-Bill rates of 0%,1%,2%, 4%,5%, and 6%. Plot these values in a graph (by hand or using Excel), with put option values on the y-axis and U.S. T-bill rates on the x-axis. What can we conclude about the relationship between foreign interest rates and foreign currency put option values? (2.5 marks) c. Calculate the estimated value of this put option for Canadian T-Bill rates of 0%,1%, 2%,4%,5%, and 6%. Plot these values in a graph (by hand or using Excel), with put option values on the y-axis and Canadian T-bill rates on the x-axis. What can we conclude about the relationship between domestic interest rates and foreign currency