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
A)0 cents.
B)3.47 cents.
C)3.55 cents.
D)3 cents.

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
A)0 cents. 
B)3.47 cents. 
C)3.55 cents. 
D)3 cents.

Quizplus · Accepted Answer

The minimum price of the American call option is given by the difference between the spot and strike price discounted by the domestic and foreign interest rates. 
The minimum price is: 
$1.28 - $1.25 × e^(0.05 × 0.5) / e^(0.04 × 0.5) = $0.0355 or 3.55 cents. 
Therefore, the correct answer is (C).

Assume That the Dollar-Euro Spot Rate Is $1