### Binomial option pricing model-black-scholes option pricing

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Question 1: Currency Options

1. If the Exchange rate is \$0.66/DM, the strike price of a call option expiring in 3 months is \$0.70/DM and the option premium is \$0.06/DM, What is the intrinsic value of the option? Does it have a time value? Explain?

Question 2: Swaps

The cost to IBM and KDB of accessing either the fixed rate yen or the floating rate dollar market for a new debt issue is as follows:

 Company Fixed rate Yen Available Floating rate Dollar Available KDB 4.9% Libor + 0.80% IBM 4.5% Libor + 0.25%

Suppose that IBM would like to borrow fixed rate yen, whereas KDB would like to borrow floating rate dollars. Answer part (a), (b) (c) and (d) below:

(a) Identify the overall spread (basis point) of the swap and at what rate should each party borrow to create the swap? IMB has competitive advantage in which rate?

(b) What is the fixed rate Yen at which IBM can borrow through interest rate/currency swap if KBD can borrow at floating rate of Libor+0.25%?

(c) Assuming a notional principle equivalent to \$125 million and a current exchange rate of Yen105/\$, what do these possible cost savings translate into in Yen terms?

(d) A fee of 8 basis points to arrange the swap. If IBM realises all the saving from the swap then what is IBM borrowing cost and what is the cost savings translate into Yen terms?

Question 3: Binomial option pricing model and Black-Scholes option pricing model

Discuss the drawbacks of the binomial option pricing model. Outline how the binomial pricing model is linked to the Black-Scholes option pricing?

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