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In: Finance

Star System Corp. signed a contract to import a cooling system from a supplier in Germany...

Star System Corp. signed a contract to import a cooling system from a supplier in Germany for €10 million payable in one year. Star System would like to control exchange rate risk when making the payment. The current spot exchange rate is $1.1/€ and one-year forward exchange rate is $1.16/€ at the moment. Star System can buy a one-year put option on €10 million with a strike price of $1.12/€ for a premium of $0.12 per euro. It can also buy a one-year call option on £10 million with a strike price of $1.15/€ for a premium of $0.15 per euro. Currently, one-year interest rate is 5% in the Germany and 4.0% in the U.S.

a. Compute the future dollar costs of meeting the payable obligation using the forward hedge.

b. Compute the future dollar costs of meeting the payable using the money market hedge. Show the steps to carry out this strategy.

c. At what forward rate do you think Star System will be indifferent between the forward hedge and MMH?

d. If Star System wants to use option hedge, what option should it use (call option or put option)? Assuming that the forward exchange rate is the best predictor of the future spot rate, compute the expected future dollar cost of meeting the obligation when the option hedge is used.

e. What hedging strategy is the best for Star System?

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Expert Solution

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

jeff jeffy answered 2 years ago
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