Combination of European exchange rate options
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You are based in the UK and have a contract with your bank to sell ? at the exchange rate £0.8/? if the exchange rate is less or equal to £0.8/? in one month's time and to sell the ? at £0.9/? if the exchange rate is greater or equal to £0.9/? at that time. Should the exchange rate lie between £0.8/? and £0.9/?, you will sell to the bank at the market exchange rate.
A.) Use a graph to show the payoff profile of your contract at maturity.
B.) In what sense does this behaviour represent a combination of European exchange rate options?
C.) Illustrate the payoff profile of a 'long' ? position hedged with such a contract.
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