1. Show that a portfolio of two options can replicate a short

forward. Follow the same steps as in the put-call parity derivation.

Use the two following options to construct the portfolio, but

remember you will be long one option and short the other:

EUR European options, maturity 3 months

Premium

Listed options Put Call

Strike price: NOK/EUR 2.25 NOK/EUR 0.001 NOK/EUR 0.001

The forward rate is as in Task 1, that is: F(NOK/EUR) = NOK/EUR

2.25.

Hint: Assume two scenarios as we did in class. One in which the spot

rate at maturity is less than strike price, S(NOK/EUR) = 2.15, and one

in which is higher than strike, S(NOK/EUR) = 2.35. Show how the

payoff at maturity of the portfolio coincide with those of the

forward.

b. Suppose now that you want to hedge your position of

Task 1, EUR 250 mln, using this portfolio of options you just constructed.

Compute the cash flows in each scenario, i.e., S(NOK/EUR) = 2.15

and S(NOK/EUR) = 2.35 and show that these coincide with those of the forward computed in Task 1a.