A Canadian firm bought textiles for €100,000 from Italy, payable in one year. And the firm is concerned about the amount of dollars they will have to pay for this purchase. Based on the quotes listed below and answer the following questions.

Spot exchange rate: $1.5/€
Forward exchange rate: $1.25/€
US interest rate: 3% per annum
Interest rate in Europe: 4% per annum
Call option with strike price of $1.3/€ is available with premium of $0.10/€ Put option with strike price of $1.3/€ is available with premium of $0.20/€

1. Unhedged position: If the company leaves the exposure unhedged. In one year, if the spot rate turns out to be $1.7/€ . What will be the total dollar cost of this purchase? What will be the total dollar cost if spot rate happens to be $1.3/€ in one year? Is the company subject to exchange rate risk?

2. Forward market hedging: If the company uses a forward contract to hedge, how can they do it? Specify the direction of position and size of the position. And what will be the total cost of this purchase with the forward hedge? Is the company subject to exchange rate risk in this case?

3. Money market Hedge: How can the company hedge using money market hedge? Specify the amount and direction of cash flows in the hedge. What is the total dollar cost of this purchase? Is there exchange rate risk in this case?

4. Option market hedge: How can the company hedge using options? Specify the direction of the position (long or short). What is the total premium paid today? When will the company exercise the options and what will be the total dollar cost if they exercise? And when will the company not exercise the options and what will be the total dollar cost then?

Answer rating: 100% (QA)

a Unhedged position The unhedged position will have a total dollar cost of 170000 if the spot rate i... View the full answer