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

question 81

Essay

Consider an option to buy €12,500 for £10,000.In the next period,the euro can strengthen against the pound by 25 percent (i.e.,each euro will buy 25 percent more pounds)or weaken 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:

Albert Bandura

A renowned psychologist best known for his Social Learning Theory, asserting that people learn behaviors through observation, imitation, and modeling.

Transference

In the psychodynamic approach to therapy, the client’s action of responding to the therapist as he or she responded to significant figures from his or her childhood (generally the parents). Considered the core of psychoanalytic therapy.

Rational-Emotive Therapy

A cognitive-behavioral approach to psychotherapy focused on changing irrational beliefs to alter dysfunctional emotions and behaviors.

Cognitive-Behavioural Approach

is a psychotherapeutic treatment that helps patients understand the thoughts and feelings that influence behaviors, focusing on solving current problems and changing unhelpful thinking and behavior.