Using options to build hedge portfolio. Consider a put option on the British pound (BP) which

represents the right to sell 1,000 at the strike price of $1.50 per .

The option will expire in one year. The current spot rate is $1.32 per . In the future, the spot rate

may become $1.40 or $1.50 per . The annual risk-free interest rate is 6.0% in the US and 5% in the

UK. A pure-discount British bond, that will pay 1,000 on the maturity date, is selling for 952.38

now.

(a) If you buy a British bond, how many puts do you have to buy or sell to construct a risk-free hedge

portfolio? What is the future dollar value of the hedge portfolio?

(b) What is the fair price of this put option?