Mexican interest rates are normally substantially higher than U.S. interest rates.
a. Assuming that interest rate parity exists, do you think hedging with a forward rate would be beneficial if the spot rate of the Mexican peso was expected to decline slightly over time?
b. Would hedging with a money market hedge be beneficial if the spot rate of the Mexican peso was expected to decline slightly over time (assume zero transaction costs)? Explain.
c. What are some limitations on using currency futures or options that may make it difficult for you to perfectly hedge against exchange rate risk over the next year or so.
d. In general, there is a lack of long-term currency futures and options on the Mexican pesos. A consultant suggests that this is no problem because you can hedge your position a quarter at a time. In other words, the profits that you remit at any point in the future can be hedged by taking a currency futures or options position three months or so before that time. Thus, while the consultant recognizes that the peso could weaken substantially in the long-term, he sees no reason why you should worry about it as long as you continually create a short-term hedge. Do you agree?