Question

4. 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:

a). unhedged strategy

b). money market hedge

c). 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?

Answer 1

I have answered the question below

Please up vote for the same and thanks!!!

Do reach out in the comments for any queries

Answer:

We can infer from that computations that it is clear that money market hedging is optimal.