Delta Airlines has just signed a contract to purchase some A$320$ planes from Airbus for

$100,000,000$ euros. The payment is due six months or $180$ days 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 $$\frac{1\mathrm{.}2000}{}.$ That is to say, $1$ euro $=1\mathrm{.}2000$ US dollars

The six$-$month forward rate is $$\frac{1\mathrm{.}2100}{}$

The company's cost of capital is $10\%$ per annum.

The euro $6-$month borrowing rate is $4\%$ per annum $($or $2\%$ for $6$ months$)$

The euro $6-$month lending rate is $2\%$ per annum $($or $1\%$ for $6$ months$)$

The US dollar $6-$month borrowing rate is $5\%$ per annum $($or $2\mathrm{.}5\%$ for $6$ months$)$

The US dollar $6-$month lending rate is $3\%$ per annum $($or $1\mathrm{.}5\%$ for $6$ months$)$

The premium on six$-$month call options on the euro with strike price $$1\mathrm{.}2100$ 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.

a$)$ Suppose that Delta Airlines were to hedge its transaction exposure using a forward

contract. Should the firm sell or buy euros forward? What is the total cost in dollars $($i$.$e$.,$

what will be the total cash outflow in dollars in six months$)?(3$ points$)$

b$)$ Suppose Delta Airlines chooses a money market hedge. Spell out the transactions that the

firm will need to undertake to implement this hedge. What is the total cost in dollars using

this hedge? $(3$ points$)$