The higher strike be to create zero-cost contract

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Reference no: EM132014689

The USD/euro exchange rate is 1.3000. The exchange rate volatility is 15%. A US company willhave to pay 1 million euros in three months. The euro and USD risk-free rates are 5% and 4%,respectively. The company decides to use a range forward contract with the lower strike equal to1.2500.

(a) What should the higher strike be to create a zero-cost contract?

(b) What position in calls and puts should the company take?

(c) Show that your answer to (a) does not depend on interest rates providing the interest ratedifferential between the two currencies, r – r f , remains the same.

Reference no: EM132014689

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