1.) In the U.S. as well as in most countries in the world, firms are subject to progressive corporate tax. Consider ABC Inc., an exporting firm, which expects to earn $25 million if the dollar depreciates, but only $15 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating, and assume the following corporate tax scheme:

Corporate income tax rate = 15% for the first $20 million.

Corporate income tax rate = 40% for earnings exceeding $20 million

ABC has two ways to hedge his risky earnings: option market hedge and forward market hedge. Of course, it can also choose not to hedge at all.

a)(2pt) Calculate the expected tax of ABC under the above tax scheme when it does not hedge

b)(2pt) By hedging with options, ABC expects to earn $23 million if the dollar depreciates, and to earn $17 million if the dollar appreciates. Calculate the expected tax of ABC with option market hedge.

c)(2pt) By hedging with forwards, ABC expects to earn $20 million regardless of the changes of the dollar exchange rate. Calculate the expected tax of ABC with forward market hedge.

d)(1pt) Comment on the strategy (whether to hedge; if hedge, which way) that ABC should adopt