Intro

Great Lakes Water exports bottled water to Europe. The company expects to receive 2,000,000 euros () in one year from its exports.

The firm expects the following exchange rate scenarios and probabilities:

Scenario	Spot rate in one year	Probability
A	$1.04	0.4
B	$1.12	0.2
C	$1.2	0.4

The spot rate is $1.12 per euro and the one-year forward rate is $1.121 per euro. The U.S. interest rate is 2% and the euro interest rate is 11%.

A put option on euros expiring in one year costs $0.007 per euro and has an strike price of $1.12 per euro.

Part 1

What is the expected dollar cash flow in one year if the company does not hedge its receivables (in $)?

Part 2

What will be the cash inflow if the firm uses a forward contract (in $)?

Part 3

What is the value of the receivables in one year with a money market hedge (in $)?

Part 4

What is the expected value of the receivables in one year with the put option hedge (in $)? Ignore the time value of money, i.e., the fact that the option premium has to be paid now rather than in a year.

Part 5

If the exchange rate turns out to be $1.28 per euro in one year, what was the cost of hedging if the company followed the optimal strategy identified in the previous part (in $)?