Assignment:
Consider an ICON (Indexed Currency Option Notes) that pays off at maturity (Time T) as follows:
-If euro-US dollar exchange rate (S) is greater than 1.25 euros per dollar at maturity, ICON holder gets $1,000.
-If S is less than 1.25 euros per dollar, the amount received by the ICON holder is reduced by max[0, 1000(1.25/S1)]
-When S is below 0.625, ICON holder gets nothing at maturity.
HINT: For easier handling of this problem, modify the payoff by writing it in terms of US dollars per euro by a simple change: Use S(T) = 1/S]
1)Draw a payoff diagram with payoff along the vertical axis and exchange rate S(T) along the horizontal axis.
2)Write this payoff in a table.
3)Break down this payoff into a combination of simpler securities that include put options