36. Hedging Decision. You believe that IRP presently exists. The nominal annual interest rate in Mexico is 14%. The nominal annual interest rate in the U.S. is 3%. You expect that annual inflation will be about 4% in Mexico and 5% in the U.S. The spot rate of the Mexican peso is $.10. Put options on pesos are available with a one-year expiration date, an exercise price of $.1008, and a premium of $0.014 per unit.

You will receive 1 million pesos in one year.

a. Determine the amount of dollars that you will receive if you use a forward hedge.

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

c. Determine the amount of dollars 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.

40. Hedging Decision. Indiana Company expects to receive 5 million euros in one year from exports.

It can use any one of the following strategies to deal with the exchange rate risk. Estimate the dollar cash flows received as a result of using the following strategies:

a. unhedged strategy

b. money market hedge

c. option hedge

The spot rate of the euro as of today is $1.10. Interest rate parity exists. Indiana Company uses the forward rate as a predictor of the future spot rate. The annual interest rate in the U.S. is 8% versus an annual interest rate of 5% in the eurozone. Put options on euros are available with an exercise price of $1.11, an expiration date of one year from today, and a premium of $.06 per unit. Estimate the dollar cash flows it will receive as a result of using each strategy. Which hedge is optimal?