QUESTION 1

Assume you are an importer in Turkey. You have bought a machine from Germany worth of 250,000. Your payment to the German firm (in ) is due in three months.

Three-month maturity TRY interest rate is 20% (annual) and same maturity EUR interest rate is -0.50% (annual). For simplicity assume that the borrowing and lending interest rates are the same. Spot exchange rate is 10.45TL/ and three-month forward exchange rate is 11.00 TL/in the foreign exchange market. The company is cash rich and in case of excess cash inflow the company invests the proceeds at an interest earning account.

There are also currency options available in the financial market.

• Exercise price of a call option with a maturity of 3 months is 11.00TL per EUR. The call premium is 0.33TL per EUR.
• Exercise price of a put option with a maturity of 3 months is 11.00TL per EUR. The put premium is 0.25TL per EUR.

What can you do in order to hedge this exchange rate exposure so that you can redenominate this three-month payable into a Turkish Lira denominated payable with three-month maturity?