Pact of Expected Volatility on Currency Option Premiums
Response to the following problem:
Assume that Australia's central bank announced plans to stabilize the Australian dollar (A$) in the foreign exchange markets. In response to this announcement, the expected volatility of the A$ declined immediately. However, the spot rate of the A$ remained at $.89 on this day, and was not affected by the announcement. The one-year forward rate of the A$ remained at $.89 on this day and was not affected by the announcement. Do you think the premium charged on a one-year A$ currency option increased, decreased, or remained the same on this day in response to the announcement? Briefly explain.