You are a Japanese investor. The current spot rate of JPY/USD is 100. In one period, the exchange rate is expected to go up to JPY/USD 110 or JPY/USD 90. The JPY risk free interest rate is 8%. There is a European call option on USD with an exercise price of JPY/USD 100. You are interested to calculate the price of the call option today.

You have an idea to form a portfolio by:

Writing 2 calls.

Buying USD 1 at spot.

Borrowing JPY 83.3333 now which is due in one period.

(a) What is the value of your portfolio in one period? State clearly the payoff for each instruments.

(b) Based on your answer in part (a), what is the value of the call option today?

Answer rating: 100% (QA)

To calculate the value of the call option today we need to determine the value of the portfolio in one period and analyze the payoffs for each instrum... View the full answer