Q1
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 Answer the following questions.
(i) How much does it cost to hold (i.e., buy) a call-HKD option? Use the Garman Kohlhagen model.
(ii) What is the minimum terminal exchange rate for the holder of the call-HKD option to profit from holding the currency option?
(iii) How much does it cost to hold (i.e., buy) a put-HKD option? Do not use the Garman Kohlhagen model.