Assume that the dollar-euro spot rate is $1.28 and the six-month forward rate is .The six-month U.S.dollar rate is 5% and the Eurodollar rate is 4%.The minimum price that a six-month American call option with a striking price of $1.25 should sell for in a rational market is

Question

Assume that the dollar-euro spot rate is $1.28 and the six-month forward rate is  .The six-month U.S.dollar rate is 5% and the Eurodollar rate is 4%.The minimum price that a six-month American call option with a striking price of $1.25 should sell for in a rational market is

Quizplus · Accepted Answer

To determine the minimum price of the American call option, we need to calculate the option value using both the spot rate and the forward rate, and then choose the higher value.

Using the spot rate of $1.28, the call option would be worth: 
$1.28 - $1.25 = $0.03

However, we can also calculate the option value using the forward rate: 
($1.25 / 1.0575) - ($1.28 / 1.025) = $0.0355

Therefore, the option should sell for at least $0.0355 or 3.55 cents.

Choice C is the closest option to this value.

Assume That the Dollar-Euro Spot Rate Is $1