Luca Electron is an electronic billboard manufacturer that specialises in manufacturing and installing billboards in sporting arenas across Asia. To fund working capital, Luca Electron needs $5,000,000 AUD for six months. The company can either borrow the $5m Australian dollars in Sydney at 6.0% p.a., or borrow the equivalent of $5m AUD in Euros at an interest rate of 2.5% p.a. and current spot exchange rate of 1.5623AUD /EUR. The expected spot exchange rate in six months is forecast to be 1.6055AUD /EUR. Assume all interest and principal repayments are made at the end of the six months at the expected exchange rate.

1. In which currency should Luca Electron borrow the money from to realise the lowest borrowing cost?
2. In six months when the loan is settled, what would the AUD/ 1EUR spot exchange rate have to be where Luca Electron is indifferent between borrowing Australian dollars and borrowing Euros?
3. If Luca Electron decides not to use a hedge, what risk does Luca Electron face by relying on the unhedged expected exchange rate in six months when they repay their loan?