Problem:
Consider a one year call on €1,000,000. The strike rate of the call is 1.35 $/€. This call gives you the option to pay $1,350,000 and receive €1,000,000 exactly one year from today. [Note: This could be viewed as a put on $1,350,000 with a strike of 1.35 $/€.] Today's spot rate is 1.25 $/€. The one year € interest rate is 1%. The one year US$ interest rate is 2%. Note: You will need to use the spreadsheet option calculator to answer c, d and e.
Required:
Question 1: What is the intrinsic value of the offered call?
Question 2: What is the breakeven exchange rate on this call option if the premium is $30,000?
Question 3: What is the price of the option if the volatility is 10%?
Question 4: What is the price of the option if the volatility is 20%?
Note: Provide thorough explanation of the given question.