You are the officer in charge of the Derivative Securities Division of an investment bank. One of your clients would like to buy a 6-month call option on the Canadian dollar and you are considering an appropriate premium for the call option.

The spot rate is currently GHS1.7000/CAD and you plan to fix the strike price at GHS1.7500/CAD. The Ghanaian cedi interest rate is 15% whilst the Canadian dollar interest rate is 2%. The instantaneous standard deviation of the CADGHS exchange rate is estimated at 10% based on variability in past currency movements.

Required:

Determine the price to be quoted for this call option using:

German-Kohlhagen model to currency option pricing.

The riskless hedge approach to binomial pricing model assuming there are only two possible outcomes for the cedi/dollar exchange rate: GHS1.6000/CAD or GHS1.9000/CAD.

The risk-neutral approach to binomial pricing model assuming there are only two possible outcomes for the cedi/dollar exchange rate: GHS1.6000/CAD or GHS1.9000/CAD.

Distinguish between intrinsic value and time value.

Explain four factors you would consider in determining the price of a currency call option.