Calculate the value of 9-month American call option to buy 1 million units of a foreign currency using a three-step binomial tree. The current exchange rate is 0.79 and the strike price is 0.80 (both expressed as dollars per unit of the foreign currency). The volatility of the exchange rate is 12% per annum. The domestic and foreign risk-free rates are 2% and 5%, respectively. What position in the foreign currency is initially necessary to hedge the risk?

I have no idea how to deal with it. I would like someone to help me out. Thanks!


closed as off-topic by Quantuple, SmallChess, Bob Jansen Jun 3 '16 at 10:22

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  • $\begingroup$ You will need to draw a binomial tree diagram and label each node with all the information then discount them back to today. $\endgroup$ – SmallChess Jun 3 '16 at 10:01
  • $\begingroup$ @StudentT Can you be more specific? $\endgroup$ – Daniel Wong Jun 3 '16 at 10:02
  • $\begingroup$ Do you know how to price with binomial model? $\endgroup$ – SmallChess Jun 3 '16 at 10:02
  • $\begingroup$ @StudentT I think so, but not skillful enough. So I think I am kind of need some explanations in detail. Thanks! $\endgroup$ – Daniel Wong Jun 3 '16 at 10:05

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