Management of Transaction Exposure

Suppose that US is your domestic country and USD is your domestic currency. You plan

to visit Geneva, Switzerland in three months to attend an international business conference.

Here, Switzerland is foreign country and SF is foreign currency. You expect to incur the total

cost of SF$5,000$ for lodging, meals and transportation during your stay. As of today, the spot

exchange rate is $$0\mathrm{.}60/$SF and the three$-$month forward rate is $$\frac{0\mathrm{.}63}{S}F.$ You can buy a

three$-$month call option on SF with the exercise rate of $$\frac{0\mathrm{.}64}{S}F$ for the premium of $$0\mathrm{.}05$ per

SF$.$ Assume that your expected future spot exchange rate is the same as the forward rate. The

annualized three$-$month interest rate is $6$ percent in the United States and the annualized

three$-$month interest rate is $4$ percent in Switzerland.

$($a$)$

$($b$)$ Suppose that the conference committee gives you a choice of paying either SF$5,000$ or

$$3,100$ in three months. In this case, this means the committee effectively gives you a free

option to buy up to SF$5,000$ using dollars. What is the "implied" exercise $$/$SF exchange rate

of this option?

$($c$)$ If the spot exchange rate three months later turns out to be $$\frac{0\mathrm{.}635}{S}F,$ which currency

would you choose to use for the payment? What is the value of this free option for you?

$($d$)$

$($e$)$ If you decide to hedge using money market instruments, what action do you need to take?

If you have to borrow the funds needed to hedge via money market instruments, what is the

amount you have to repay three months later?

$($f$)$ Calculate both the present value and the future value of your expected dollar costs of

buying SF$5,000$ if you would choose to hedge by buying a call option on SF$.$

$($g$)$ At what future spot exchange rate will you be indifferent between the forward and the

option market hedging? At this break$-$even future spot exchange rate, will the option be

exercised or not?

$($h$)$ Illustrate graphically the future dollar costs of meeting the SF payable against the future

spot exchange rate under both the option and the forward market hedging.

$($i$)$ At what future spot exchange rate will you be indifferent between the option and the

money market hedging?

Please assist in drafting potential questions that my teacher may ask for both Part a and d$.$ Subsequently, provide answers spanning from a to i $,$ inclusive of the questions you will be drafting for Part a and d$.$