Assume that today is September 12. You have been asked to help a British client who is scheduled to pay €1,500,000 on December 12, 91 days in the future. Assume that your client can borrow and lend pounds at 5% p.a.

a. Describe the nature of your client’s transaction exchange risk.

b. What is the option cost for a December maturity and a strike price of £0.72/€ to hedge the transaction? The option premiums per 100 euros are £1.70 for calls and £2.40 for puts.

c. What is the minimum pound cost your client will experience in December?

d. Determine the value of the spot rate (£/€) in December that makes your client indifferent ex post to having done the option transaction or a forward hedge if the forward rate for delivery on December 11 is £0.70/€.