Mr. B just signed a contract to play professional basketball in Mexico for the Mexican Stars. The team owner has agreed to pay his living expenses for two years and an annual salary of \(2,000,000\) pesos, with \(1,000,000\) pesos to be paid one year from the present and the second-year 1,000,000 pesos to be paid two years from the present. Mr. B plans to play two years, then return to the United States. He would like to hedge the dollar value of his contract. Currently, the spot \(\$ /\) peso exchange rate is \(\$ 0.05 /\) peso and the Mexican risk-free rate is \(6 \%\) (annual), the US risk-free rate is \(2 \%\). Forward rates offered by US and Mexican banks are governed by the IRPT.
a. Explain how Mr. B could hedge the dollar value of his salary using forward contracts.
b. Suppose Mr. B could not find a bank to provide him with a forward contract. Explain how he could alternatively hedge his salary against exchange rate risk by using the money market. Assume Mr. B can borrow pesos at 6\% and can invest dollars at \(2 \%\).