Part 5. (Currency options) Suppose you are importing clothes from Japan and you have Yen 6,250,000 payable due in 90 days. The current spot rate is $0.005 per Yen. The 90-day forward rate is 0.0054. Currently, the currency option market offers Yen call option with a maturity date in 90 days and a strike price of 0.0053. The premium of this option is $0.0002/yen. Note that one unit of Japanese Yen option contract is 6,250,000 Yen. You are considering two possible hedging methods: (a) use forward, (b) use option.

(1) You expect that the actual spot rate in 90 days would be 0.006 $/Yen. Which hedging method, (a) or (b), would you choose? Support your answer by calculating potential gain or loss of each method.

(2) If the actual spot rate in 90 days turned out to be 0.005 $/Yen, then which hedging method would have been a better choice (evaluate each choice by calculating ex post gains or losses)? Why? (Note that wait and use spot market later is not considered.)

(3) You expect that the actual spot rate in 90 days would be higher than 0.0052 for sure. Which method would you choose, options or forward? Explain.