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Question 1
Consider the option on currency HKD against the USD:
Current spot rate is HKD7.50 for 1 USD:
· Risk-free HKD rate of interest is 5% p.a.
· Risk-free USD rate of interest is 2% p.a.
· Volatility (σ) of the currency returns is 20% p.a.
· Maturity of the option is 3 months.
· Strike rate of the option is HKD8.00 for 1 USD
· The currency options are European in nature
(a) Draw the terminal payoff diagram for the holder of the currency call option on HKD.
(b) Draw the terminal payoff diagram for the holder of the currency put option on USD.
(c) How much does it cost to hold (i.e., buy) a call-HKD option? Use the Garman Kohlhagen model.
(d) What is the minimum terminal exchange rate for the holder of the call-HKD option to profit fromholding the currency option?
(e) How much does it cost to hold (i.e., buy) a put-HKD option? Do not use the Garman Kohlhagen model.
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