At writing, 1 Euro is equivalent to 0.89 GBP (i.e., British pounds). Assume that the interest...

At writing, 1 Euro is equivalent to 0.89 GBP (i.e., British pounds). Assume that the
interest rate over one (annual) timestep in Britain is rGB = 1:5%, and in Europe, it
is rE = 2:0%. Operate in CRR notation with u = 1:15, and d = 1=u throughout this
question, and specify which currency you are using in all answers.
Assume that your domestic currency is GBP.

(i) Calculate the risk neutral probability for an exchange rate option. Let each
time step represent one year, so you can use the interest rates given without
conversion.
(ii) Assume the strike rate of an exchange rate (European) call option is k = 1:00
GBP/EUR, and the face value is F = EUR10; 000. Construct a binomial
tree and calculate the premium of this call option, in GBP.
(iii) Using the same strike rate and face value, calculate the premium of an ex-
change rate European put (in GBP).

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jeff jeffy answered 1 year ago

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