The pound spot rate is currently S = 50.1$ / £ . It is projected that the spot rate will either increase to 70.1$ Su = if US economic conditions worsen over the next year, or decline to 40.1$ Sd = if conditions improve. Eurodollar bank accounts require 1$ B = to set up and are paying zero interest. Call options on the pound currently have a strike price of X = 55.1$ .
a) Calculate the amount of pounds, NS , and the amount of dollars in the bank account, NB , required to replicate the payoffs of the call option.
b) What is the value, V, of the replicating portfolio?
c) What is the value, c, of the call option? Why must it equal V?