Question

You are required to price a one-year, yen-denominated currency option on the USD. The exchange rate over the next year is modeled using a forward binomial tree with the number of periods equal to 4. Assume that the volatility of the exchange rate equals 0.1. The continuously compounded risk-free interest rate for the yen equals 0.05, while the continuously compounded risk-free interest rate for the USD equals 0.02. What is the value of the so-called up factor u in the resulting forward binomial tree

Answer 1

Answer:

The value of the so-called up factor is

$u = 1.1618$

Step-by-step explanation:

From the question we are told that

The number of period is n = 4

The volatility of the exchange rate is $v = 0.1$

The continuously compounded risk-free interest rate for the yen is r = 0.05

The continuously compounded risk-free interest rate for the USD is R = 0.02

Generally the so-called up factor u is mathematically represented as

$u = e^{v + r}$

=>       $u = e^{0.1 + 0.05}$

=>       $u = e^{0.15}$

=>       $u = 1.1618$