A comparison of hedging techniques that a MNC can utilize should focus on obtaining foreign currency at the lowest possible cost. Assume that Eco Ltd will need to pay $200 000 in 180 days. It is considering using: (1) a forward hedge, (2) a money market hedge, (3) an option hedge, or (4) no hedge. Its analysts compile the following information, which can be used to assess the alternative solutions:

Spot rate = 0.60 for $1

180-day forward rate = 0.61 for $1

Interest rates are as follows:

UK US

180-day deposit rate 4.5% 4%

180-day borrowing rate 5.5% 5%

A call option that expires in 180 days has an exercise price of 0.61 and a premium of 0.021. The size of the contract is $200 000.

A put option that expires in 180 days has an exercise price of 0.59 and a premium of 0.004. The size of the contract is $200 000.

Eco Ltd forecasts the future spot rate in for $ in 180 days as follows:

Possible outcomes Probability

0.75 1%

0.70 9%

0.66 22%

0.63 33%

0.58 23%

0.56 10%

0.53 2%

Required:

Using relevant cash flow analysis, you are required to make a comparison of the four hedging techniques and to recommend the most appropriate strategy