Assume that the German mark spot rate is $0.5891 and the six-month forward rate is $0.5971. Also, assume that the six-month Eurodollar rate is 6%.
-You paid $0.1 for a one-year European call option for £1 with the strike price of $1.7/£.At which exchange rates on the maturity date will you exercise your option?

Question

Quizplus · Accepted Answer

To exercise the option, the spot rate on the maturity date should be greater than the strike price of $1.7/£. 
We can convert the strike price to USD as follows: 
1.7/£ x 0.5891 = $1.00047/£ 
To make a profit, the spot rate on the maturity date needs to be higher than the cost of the option plus the strike price, which is: 
$0.1/£ + $1.00047/£ = $1.10047/£ 
Therefore, if the spot rate on the maturity date is more than $1.10047/£, exercising the option would result in a profit. Since the six-month forward rate is $0.5971, the estimated spot rate on the maturity date would be higher than the current spot rate. Thus, option C is the best choice.

Assume That the German Mark Spot Rate Is $0