Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm


Postby » Wed Oct 16, 2013 11:54 am

If the current USD/AUD rate is 0.6650 (1 AUD=0.6650USD) and the risk-free rates for the USD and AUD are 1.0% and 4.5% respectively, what is the lower bound of a 5-month European put option on the AUD with a strike price of 0.6880?
Choose one answer.
Choose one answer.
a. 0.0325 Correct
b. 0.0245 Incorrect
c. 0.0455 Incorrect
d. 0.0135 Incorrect
The correct answer is 0.0325 .
The lower bound for a European option is given by the formula: Xe -rT- Se-rfT, where X is the strike price, r is the risk-free rate of the USD, r f is the risk-free rate of the AUD,T is the time to maturity and S is the spot rate of the AUD/USD.
Thus, the lower bound = 0.6880 x [exp-(0.01x 5/12)] – 0.6650 x [exp-(0.045x 5/12]] = 0.6880 x (0.9958) –0.6650 x (0.9814)= 0.6851 – 0.6526 = 0.0325

How to find which rate is domestic and which is foreign rate- Is it always USD as domestic rate... I do mistakes in this ... Can you please help me

Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm


Postby pradeeppdy » Fri Oct 18, 2013 6:23 am

Always remember Foreign/ Domestic. Do not always look at answer try to do itself then you will able to find out the reason.

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