(20 %) 1. Option pricing, binomialmodel The NOK/GBP exchange rate is 10.95, the one-year interest rate in Norway is 0.5% and the one-year interest rate in Great Britain is 0.75% . Duringeach ofthe next two six-months periods the exchange rate may either increase or decrease by 0.25 NOK /GBP . Use the binomial model to estimate the price of a one-year European calloption on GBP with strike at 11.00 NOK /GBP. (20 % ) 2. Option pricing, Black Scholes, replication The USD / EUR exchange rate is 1.22, the one-year dollar interest rate in the United States is 2.0%, the one-year euro interest rate in Germany is -0.5%, and the annualized volatility of the exchange rate is 8% . (a) The Black-Scholes form ula for a European-style currency call option is C = S . N(d1) . e - PT _ X . N(d2) . er.T hvor In S . e- PT / X + ( r + 0 2/ 2) T d1 = OVT d2 = d1 _ ovT where N (. ) is the cumulative probability distribution p is the continuously compounded interest rate in currency 1 r is the continuously compounded interest rate in currency 2 T is time to maturity of the option S is the current spot exchange rate in terms of country 1 / country 2 X is the strike price Use the formula to compute the at-the -money call option on USD / EUR . (b ) Assume that the call option is not traded in the market. You would like to replicate the option using a portfolio of USD and EUR . (Hint: This part of the question should not require much effort.)