A U.S. firm, Haring Inc., places an order to purchase a machine from an Italian firm, Caravaggio Inc. Haring and Caravaggio agree on a transaction price of €350,000. The funds will be transferred in one year.
 

a. Haring Inc. is considering entering into a forward contract to hedge the currency mrisk associated with the transaction. The current one-year Euro-Dollar forward exchange rate is €0.862/$. If Haring Inc. enters into this forward contract with size €350,000, how much will it cost (in dollars) for Haring Inc. to purchase €350,000 in one year?

 

b. The Euro-Dollar spot exchange rate today is €0.875/$, and the dollardenominated risk-free rate is 3% per year, while the euro-denominated risk-free rate is 4% per year. Should Haring Inc. enter the forward contract with the forward rate of €0.862/$ or should Haring pursue a cash-and-carry strategy?

 

c. Assume Haring enters into the forward contract with the exchange rate €0.862/$. Suppose that the Euro-Dollar spot exchange rate in one year is €0.870/$. How much did Haring lose or gain (in dollars) on their forward contract position?

 

e. Now, suppose a currency option to purchase Euros with an exercise price of $1.145/€ in one year costs $0.04/€. If Haring uses the option to hedge and the spot rate in one year ends up being $1.140/€, how much would it cost to purchase the €350,000? 

 

f. Now, suppose a currency option to purchase Euros with an exercise price of $1.139/€ in one year costs $0.04/€. If Haring uses the option to hedge and the spot rate in one year ends up being $1.140/€, how much would it cost to purchase the €350,000?
 

g. Contrast the relative advantages of hedging with forward contracts with those of hedging with option contracts.