Question: A call and a put option are written on 12.5 million with a strike price equal to the current exchange rate of 100/$ and the

A call and a put option are written on ¥12.5 million with a strike price equal to the current exchange rate of ¥100/$ and the current discrete interest rates are R_€ = 5% and R_¥ = 1%. Use one step recombining tree with u = 1.25. Assume that the one-step binomial tree is providing enough accuracy for hedging decisions.

An EU importer has a ¥100m payable due in one year who considers using options to eliminate exchange rate risk. Ignore time value in calculating the cost.

What is risk-neutral probability for a spot rate.

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