Mexican interest rates are normally substantially higher than U.S. interest rates.

a. Assuming that interest rate parity exists, do you think hedging with a forward rate will be beneficial if the spot rate of the Mexican peso is expected to decline slightly over time?

b. Will hedging with a money market hedge be beneficial if the spot rate of the Mexican peso is expected to decline slightly over time (assume zero transaction costs)? Explain.

c. What are some limitations on using currency futures or options that may make it difficult for you to perfectly hedge against exchange rate risk over the next year or so?

d. In general, not many long-term currency futures and options on the Mexican peso are available. A consultant suggests that this is not a problem because you can hedge your position a quarter at a time. In other words, the profits that you remit at any point in the future can be hedged by taking a currency futures or options position 3 months or so before that time. Thus, although the consultant recognizes that the peso could weaken substantially in the long term, she sees no reason why you should worry about its decline as long as you continually create a short-term hedge. Do you agree?