Goro Inc (Goro), a US firm, has an outstanding contractual obligation with its French supplier for a total amount of 6 million to be paid in nine months. The firm is thinking of hedging its position by buying option contracts (contract size is 250,000) at a strike price of 0.769/$ in order to protect against the risk of the rising euro. The option premium is 1.7 dollar cents per euro.

Alternatively, Goro can sign nine-months futures contracts (contract size 0.6 million) at a futures price of 0.762/$. The current sport rate is 0.769/$. The financial director has been advised by one forex expert that the most likely value for the euro in 270 days is 0.771/$, but she also believes that the euro could go as high as 0.754 or as low as 0.775 against the $.

Note: Assume there are 360 days in a year.

(i) Indicate which type of option contract Goro should buy. Prepare a profit/loss diagram on the option position and the futures position within the range of expected future spot prices. (30 marks)

(ii) Calculate what Goro would gain or lose on the option and futures position if the euro settled at its most likely value. What is Goros break-even future spot price on the option contract? (30 marks)

(iii) Prepare a diagram of the corresponding profit and loss and break-even positions on the futures and option contracts for the sellers of these contracts. (15 marks)

(iv) Briefly discuss the advantages and disadvantages of using currency futures versus currency options to hedge exchange rate risk. (25 marks)