Options on an exchange rate can be valued using the formula for an option of a stock paying a continuous dividend yield where the dividend yield is replaced by: choose one)
A) The domestic risk-free rate
B) The foreign risk-free rate
C) The foreign risk-free rate minus the domestic risk-free rate
D) None of the above

Question

Quizplus · Accepted Answer

Options on exchange rates can be valued similarly to options on stocks that pay a continuous dividend yield. In this context, the foreign risk-free interest rate plays a similar role to the dividend yield in the stock options formula. This is because holding foreign currency can be seen as analogous to holding a stock that pays a continuous yield, where the yield is the interest that could be earned on the foreign currency.

Options on an Exchange Rate Can Be Valued Using the Formula