Kansas Corp., an American company, has a payment of €5 million due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $5,555,556, but Kansas faces the risk that the €/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5 million forward today at a oneyear forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $100,000 for a one-year call option on €5 million at an exchange rate of 0.88 €/$.

a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas’s net dollar cost for the payable under each strategy?

b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas’s net dollar cost for the payable under each strategy?

c. Which hedging strategy would you recommend to Kansas Corp.? Why?

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