2. Union Corp must make a single payment of 5 million in six months at the maturity of a payable to a French firm.

The finance manager expects the spot price of the to remain stable at the current rate of $1.60/.

But as a precaution, the manager is concerned that the rate could rise as high as $1.70/ or fall as low as $1.50/.

Because of this uncertainty, the manager recommends that Union Corp hedge the payment using either options or futures.

Six months Call and Put options with an exercise price of $1.60/ are available.

The Call sells for $.08/ and the Put sells for $.04/. A six-month futures contract on is trading at $1.60/.

• Should the manager be worried about the dollar depreciating or appreciating?
• If Union Corp decides to hedge using options, should it buy Calls or Puts to hedge the payment? Why?
• If futures are used to hedge, should the company buy or sell futures? Why?
• What will be the net payment on the payable if an option contact was used?

Assume the following three scenarios: the spot price in six months will be $1.50/, $1.60/, or $1.70/.

• What will be the net payment if futures had been used to hedge using the same scenarios as above.
• Which method of hedging is preferable?

3. Explain what an arbitrageur would do in the following circumstances.

• $/SF exchange rate is $.51/SF, the Swiss risk-free rate is 4% per year, the US risk free rate

is 6% per year, and a SF Call option with an exercise price of $.50/SF and a three-month

expiration is trading at $.01/SF.

• $/SF exchange rate is $.48/SF, the Swiss risk-free rate is 4% per year, the US risk free rate

is 6% per year, and a SF Put option with an exercise price of $.50/SF and a three-month expiration

is trading at $.01/SF.

• $/SF exchange rate is $.52/SF, the Swiss risk-free rate is 4% per year, the US risk free rate

is 6% per year, and a SF Put option with an exercise price of $.50/SF and a three-month expiration is

trading at $.0075, and a SF Call with similar terms is trading at $.04