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 Euro's 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.

Required:

1. In which currency should Luca Electron borrow the money from to realise the lowest borrowing cost?(5 marks)
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 marks)
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?(2 marks)