Assume that today is March $7$ and, as a member of the options desk at Morgan Stanley, you must advise a client on the costs and benefits of hedging a transaction with options. Your client $($a small U$.$S$.$ importing firm$)$ is scheduled to make a payment of $7,550,000$ on May $12,66$ days in the future. Assume that your client can borrow and lend at a $5\%$ p$.$a$.$ U$.$S$.$ interest rate.

a$.$ Describe the nature of your client$$s transaction exchange risk

b$.$ Use the appropriate American option with a May maturity and a strike price of $109/$ to determine the dollar cost today of hedging the transaction with an option strategy. The cost of the call option is $3\mathrm{.}93/,$ and the cost of the put option is $1\mathrm{.}58/.$

c$.$ What is the maximum dollar payment your client will make in May? Remember to take account of the opportunity cost of doing the option hedge.

d$.$ Determine the value of the spot rate $($$$/)$ in May that would make your client indifferent ex post to having done the option transaction or a forward hedge. The forward rate for delivery on May $12$ is $$1\mathrm{.}15/.$