2. Pax Americana hedges its Mexican peso translation exposure (B-beginner).

Referring to Pax Americana’s translation exposure described in problem 1:

a. Identify the alternative hedging methods available to Pax Americana.

b. Show how Pax Americana could hedge its MXN exposure if one-year peso forward contracts trade at MXN 14 = US$1.

c. What is the cost of hedging through forward contracts? Is this tax-deductible?

d. An alternative approach is for Mexicana Ltd. to borrow Mexican pesos and convert them immediately to U.S. dollars. Explain how the latter approach effectively eliminates Pax Americana’s exposure in pesos. What is the cost of this approach, assuming that pesos can be borrowed/lent at 8.5 percent per annum and U.S. dollars return 3.5 percent annually on the Eurodollarmarket?

e. Which hedging method should Pax Americana select? Compare the two methods graphically.