Problem 14 (Transaction Exposure to Currency Risk):

You plan to visit Geneva, Switzerland, in three months to attend

an International Student Conference.

You expect to incur a total cost of CHF 5,000 for lodging, meals, and transportation during your stay.

As of today, the spot exchange rate is USD 0.60 / CHF and the three-month forward rate is USD 0.63 /

CHF. You can buy a three-month call option on CHF with an exercise price of USD 0.64 / CHF for the

premium of USD 0.05 / CHF. Assume that your expected future spot exchange rate is the same as the

forward rate. The three-month interest rate is 6 percent per year in USD and 4 percent per year in CHF.

a.

Calculate your expected dollar cost of buying CHF 5,000 if you choose to hedge by a call

option on CHF.

b.

Calculate the future dollar cost of meeting this CHF obligation if you decide to hedge using a

forward contract.

c.

At what future spot exchange rate will you be indifferent between the forward and the option

market hedges?