40 Hedging decision. You believe that IRP presently exists. The nominal annual interest rate in Mexico is 14%. The nominal annual interest rate in the United Kingdom is 6%. You expect that annual inflation will be about 4% in Mexico and 5% in the United Kingdom.

The spot rate of the Mexican peso is £0.65.

Put options on pesos are available with a one-year expiration date, an exercise price of £0.70, and a premium of £0.07 per unit. You will receive 1 million pesos in one year.

a Determine the expected amount of British pounds that you will receive if you use a forward hedge.

b Determine the expected amount of pounds that you will receive if you do not hedge and believe in purchasing power parity.

c Determine the amount of pounds that you will expect to receive if you use a currency put option hedge. Account for the premium you would pay on the put option.