A U.S.-based MNC has just signed a contract with a German company that calls for the U.S. MNC to provide the German company with consulting services over a three-month period that entails payments in euros. At the spot rate of $1.0782/, the current dollar value of the contract is $175 million. At the same time the U.S. company signs a three-month contract with another German company to buy supplies for three- month delivery and agrees to settle its bill in euros. The current dollar value of the euro contract is $45,616,000. At the same time, the U.S. MNC signs a contract to export $60 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 $1.0782/ Bid $1.0926/ Ask

3-month forward $1.0764/ Bid $1.0908/ Ask

6-month forward $1.0876/ Bid $1.1020/ Ask

3-month futures $1.0762/ Bid and $1.0906/

90-day call option #1 $ 1.0805/ strike; $ 0.0390/ premium

90-day put option #1 $ 1.0805/ strike; $ 0.0040/ premium

180-day call option #2 $ 1.0808/ strike; $ 0.0092/premium

180-day put option #2 $ 1.0808/ strike; $ 0.0104/ premium

90-day dollar interest rate 6.40% per annum (deposit) 7.20% per annum (loan)

90-day euro interest rate 6.80% per annum (deposit) 7.40% per annum (loan)

Assume the following probability distribution for the euro 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

$1.0960/ 30%

$1.0380/ 40%

$1.0210/ 30%