A U.S. firm imports 10 million of goods from a German firm, and needs to pay the full amount to the firm in 6 months. This U.S firm is engaging in the money market hedge in order to eliminate the transaction exposure. The following rates are available to the US firm: 6 month US interest rates = 3%, 6 month German interest rates = 5%, and the spot exchange rate (S^$/) = $1.20/.

a. Describe the money market hedging strategy for the US firm. Be specific.

b. Now, suppose that the six month forward rate is available to the US firm at the rate of $1.20/. Describe the forward hedging strategy to cover the 10 million payables. Be specific.

c. Which hedging strategies (money market hedge or forward hedge) would be better (less expensive) to employ? Explain why.

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