Delta Airlines has just signed a contract to purchase some A320 planes from Airbus for 500,000,000 euros. The payment is due six months later. You are in the Treasury department of Delta Airlines and need to make a recommendation to the Treasurer regarding how best to hedge the exchange rate risk of this transaction. You have gathered the following information: " The spot exchange rate is $1.1000/ " The six month forward rate is $1.0960/ " The company's cost of capital is 10% per annum. " The euro 6-month borrowing rate is 4% (or 2% for 6 months) " The euro 6-month lending rate is 2% (or 1% for 6 months) " The US dollar 6-month borrowing rate is 3% (or 1.5% for 6 months) " The US dollar 6-month lending rate is 1.5% (or 0.75% for 6 months) " The premium on six-month call options on the euro with strike price $1.1000 is 2%. You would like to compute the total cost in dollars of each hedging alternative. Note that the phrase "total cost in dollars" refers to the total cash outflow in dollars when the payment is made in six months. Also, keep in mind that cash flows that occur at different points in time are not directly comparable. You need to put them on a common footing by computing their present value or future value.

Suppose Delta Airlines decides to hedge using a call option on the euro. Suppose that the spot rate in 6 months is $1.15 per euro. What will be the total cost in dollars after taking into account (the future value of) the cost of the option? Suppose that the spot rate in 6 months is $1.05 per euro. What will be the total cost in dollars after taking into account (the future value of) the cost of the option?

Suppose that you strongly expect the euro to appreciate. In that case, which of the hedging alternatives would you recommend? Briefly justify your recommendation

Suppose that you expect the euro to depreciate. By how much does the euro need to depreciate in order to make the call option a better alternative than the forward contract? In other words, how low does the euro have to go in value to make the call option a better alternative than the forward contract? Support your answer with calculations.