A U.S. based MNC has just signed a contract with a British company that calls for the U.S. MNC to provide the British company with consulting services over a three-month period that entails payments in British pound. The current dollar value of the contract is $128 million. At the same time the U.S. company signs a three-month contract with another British company to buy supplies for three- month delivery and agrees to settle its bill in British pounds. The dollar value of the British pound contract is $35.744 million. At the same time, the U.S. MNC signs a contract to export $85 million worth of its finished product to Ecuador. Also, for delivery and settlement in three months (Ecuador uses the U.S. dollar as its home currency). The U.S.-based MNC is particularly worried about a high degree of uncertainty in the foreign exchange markets. So, it decides to evaluate its hedging alternatives. The following information is available:

Spot $1.1532/ Bid $1.1736/ Ask

3-month forward $1.1530/ Bid $1.1734/ Ask

6-month forward $1.1584/ Bid $1.1788/ Ask

3-month futures $1.1528/ Bid and $1.1732/

90-day call option #1 $ 1.1632/ strike; $ 0.0130/ premium

90-day put option #1 $ 1.1632/ strike; $ 0.0100/ premium

180-day call option #2 $ 1.1686/ strike; $ 0.0204/ premium

180-day put option #2 $ 1.1686/ strike; $ 0.0320/ premium

90-day dollar interest rate 6.20% per annum (deposit) 7.00% per annum (loan)

90-day pound interest rate 5.60% per annum (deposit) 6.40% per annum (loan)

I. Specify exactly what your exposure is and list the hedging alternatives you should consider.

II. Show how each of these hedging alternatives can be achieved.

III. Assume the following probability distribution for the pound spot rate at the end of three months. Analyze the option versus the no-hedge alternatives and decide which alternative is probably the better one of the two and why. S1 Probability $1.1960/ 30% $1.1380/ 40% $1.1210/ 30%

IV. Show how you compare all alternatives in terms of cost/benefit and risk and how to choose the best alternative.