Indiana Company expects to receive 5 million euros in one year from exports. It can use...

Indiana Company expects to receive 5 million euros in one year from exports.

It can use any one of the following strategies to deal with the exchange rate risk. Estimate the dollar cash flows received as a result of using the following strategies:

unhedged strategy

money market hedge

option hedge

The spot rate of the euro as of today is $1.30. Interest rate parity exists. Indiana Company uses the forward rate as a predictor of the future spot rate. The annual interest rate in the U.S. is 6% versus an annual interest rate of 4% in the eurozone. Put options on euros are available with an exercise price of $1.25, an expiration date of one year from today, and a premium of $.04 per unit. Estimate the dollar cash flows it will receive as a result of using each strategy. Which hedge is optimal?

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Expert Solution

From the above workings, it is clear that money market hedging is optimal.

jeff jeffy answered 1 year ago

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