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Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates...

Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

Big hint: don't round, keep exchange rates out to at least 4 decimal places.

Spot Rates Risk-free Rates
S0($/€) $1.60 = €1.00 i$ 3.00%
S0($/£) $2.00 = £1.00 i€ 4.00%
S0(€/£) €1.25 = £1.00 i£ 4.00%

State the composition of the replicating portfolio; your answer should contain "trading orders" of what to buy and what to sell at time zero.

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Answer:-

I HAVE TRIED TO EXPLAIN IN SIMPLE MATHS WAY.

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

jeff jeffy answered 1 year ago
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