1. (15 points)Indiana Co. expects to have to pay EUR 5,000,000 in one year for imports and it considers hedging its exchange rate risk.

The spot rate of the euro as of today is 1.10 USD/EUR. Interest rate parity exists.

Indiana Co. uses the forward rate as a predictor of the future spot rate. The annual

interest rate in the United States is 3%, versus an annual interest rate of 1% in the

Eurozone.

Call options on euros are available with an exercise price of 1.14 USD/EUR, an

expiration date of 1 year from today, and a premium of .06 USD/EUR. Estimate

the dollar cash amount that Indiana Co. will pay as a result of using each of the

following strategies:

(a) unhedged strategy

(b) forward hedge

(c) money market hedge

(d) option hedge

Which hedge is optimal?