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...

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.