# |Question 3. Currency Option Pricing with Binomial Model (10 marks) {in January 11, the spot exchange rate for the U.S. dollar is \$.?

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|Question 3. Currency Option Pricing with Binomial Model (10 marks) {in January 11, the spot exchange rate for the U.S. dollar is \$ﬂ.?ﬂ per Canadian dollar. Inone year’s time, the Canadian dollar is expected to appreciate by ED percent or depreciateby 15 percent. We have a European put option on U.S. dollars expiring in one year, with anexercise price of 1.39 CND\$IUS\$, that is currently selling for a price of \$2.93. Each putopﬁon gives the holder the right to sell 1i},DﬂD U.S. dollars. The current one—year CanadianTreasury Bill rate is 2 percent, while the one—year ”.5. Treasury Bill rate is 3 percent, bothcompounded annually. Treat the Canadian dollar as the domestic currency. b. Calculate the estimated value of this put option for U.S. T—Bill rates of [1%, 1%, 2%,4%, 5%, and 5%. Plot these values in a graph [by hand or using Excel), with putoption values on the y—axis and U.S. T—bill rates on the x—axis. What can we oonclude about the relationship between foreign interest rates and foreign currency put optionvalues? {2.5 marks} c. Calculate the estimated value of this put option for Canadian T—Bill rates of (1%, 1%,2%, 4%, 5%, and 6%. Plot these values in a graph [by hand or using Excel], withput option values on the y-axis and Canadian T-bill rates on the x-axis. What can weconclude about the relationship between domestic interest rates and foreign currencyput option values? {2.5 marks]

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