Exotic Options – Foreign Equity-Linked Foreign Exchange Options in Domestic Currency

File Name: Exotic Options – Foreign Equity Linked Forex Options

Location: Modeling Toolkit | Exotic Options | Foreign Equity Linked Forex

Brief Description: Computes the option where the underlying asset is in a foreign market, the exchange rate is fixed in advance to hedge the exposure risk, and the strike price is set as a foreign exchange rate rather than a price

Requirements: Modeling Toolkit

Modeling Toolkit Functions Used: MTEquityLinkedFXCallOptionDomesticValue, MTEquityLinkedFXPutOptionDomesticValue

Equity-Linked Foreign Exchange Options are options (see Figure 49.1) whose underlying asset is in a foreign equity market. The option holder can hedge the fluctuations of the foreign exchange risk by having a strike price on the foreign exchange rate. The resulting valuation is in the domestic currency. There are three closely related models in this chapter and the following two chapters (foreign equity-linked foreign exchange option, foreign equity struck in domestic currency, and foreign equity with fixed exchange rate in domestic currency). Their similarities and differences can be summarized as follow:

• The underlying asset is denominated in a foreign currency.
• The foreign exchange rate is domestic currency to foreign currency.
• The option is valued in domestic currency.
• The strike prices are different where:

1. The exchange rate is the strike for the foreign equity-linked foreign exchange option.
2. The domestic currency is the strike for the foreign equity struck in the domestic currency option.

Figure 49.1: Equity-linked options