Consider an Option to Buy £10,000 for €12,500 Find the Risk Neutral Probability of an "Up" Move

question 93

Essay

Consider an option to buy £10,000 for €12,500.In the next period,if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent.On the other hand,the euro could depreciate against the pound by 20 percent.
Big hint: don't round,keep exchange rates out to at least 4 decimal places.

$\begin{array}{lll}&spot Rates&Risk-tree Rates\\S_{0}(\$ / €) & \$ 1.60=€ 1.00&i \$ 3.00 \% \\S_{0}\left(\$ / £)\right. & \$ 2.00=£ 1.00&i €4.00 \% \\S_{0}\left(€ /£)\right. & € 1.25=£ 1.00&i £4.00 \%\end{array}$ Find the risk neutral probability of an "up" move.

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Definitions:

Type of Isolation

Various forms of separation in biology that prevent species from mating and producing viable offspring, critical in the process of speciation.

Arctic Fox

A small mammal adapted to living in cold climates, known for its thick fur and opportunistic feeding habits.

Grey Fox

A small carnivorous mammal native to North and Central America, known for its gray fur and ability to climb trees.

Generalist

An organism that is able to thrive in a wide variety of environmental conditions and can make use of a variety of different resources.