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Assumption of risk neutrality

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Using a one-step binomial tree, explain how the assumption of risk neutrality is used to develop the equations for the risk neutral valuation of options. Assume that the current exchange rate GBP/JPY is ????0=130 and in the next six months it either moves up to 140 or down to 110. The risk-free interest rate in JPY is 0% and in GBP is 2% per annum (reported with continuous compounding). Determine the risk neutral probability for an upward movement in the exchange rate. Explain your approach. Determine the value of a six-month exchange rate put option with a strike price of K=135.

Reference no: EM131803800

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