Consider an Option to Buy €12,500 for £10,000 Find the Cost Today of Your Hedge Portfolio in Pounds

question 19

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 cost today of your hedge portfolio in pounds.

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Definitions:

Retained Earnings

Profits that a company keeps after dividends are paid, which can be used for reinvestment in the business or to pay down debt.

Liabilities

Financial obligations or debts a company owes to external parties.

Cash

Liquid assets held by an entity that can be immediately used for transactions.

Ex-dividend Date

The specific date on which shares of a company stop coming with the right to receive the most recently declared dividend, usually set two trading days before the record date.