You are considering USD to EUR exchange rate. The current spot rate is 1.5 USD/EUR, and there is a call option with the strike price of 1.5 USD/EUR and the time to maturity of one year. This call option is issued on 10,000 EUR. (10 points)

1) Suppose that in one year the spot rate will be 1.8 USD/EUR or 1.2 USD/EUR (only two states). What will be possible payoffs from the call option for the two states?

2) Replicate the cashflow you described in 1) by using a bond in the euro area and borrowings in USD (specify the amounts, face value, etc.). Then show the cashflows (in one year) of your replicating portfolio.

3) Compute the call option price by computing the price of your replicate portfolio in 2). Assume the interest rate in US is 0.06 and that in the euro zone is 0.05.