Question 2 A. Critically evaluate the following statement: "David Ricardo's principle of comparative advantage teaches that if countries learn to specialize and exchange, then overall wealth will increase and productivity will increase." (35 marks) B. It is the beginning of September and a Belgian company expects to receive $8.28m in 6 month's time from a U.S. customer. Traded option prices (contract size 125,000) are currently as follows: Exercise Price ($/) 1.35 1.38 1.41 December March Calls Puts Calls Puts 2.02 0.83 2.58 1.01 1.70 1.60 2.02 1.97 0.81 2.55 1.67 3.13 Option premiums are quoted in dollar cents per and are payable up front. These are American-style options. Assume that the current spot exchange rate is $1.34/. In answering the questions below, where appropriate, refer to the information above. Required: i. Calculate how many option contracts the company should enter into to hedge the transaction assuming an exercise price of $1.38/ is chosen. (10 marks) ii. State whether the company should enter into a call or put option and whether it should use December or March contracts. Explain the reasons for your choice. (10 marks) iii. Calculate the cost, to the nearest , of the premium to obtain the required number of contracts to hedge the transaction at an exercise price of $1.38/. iv. V. (10 marks) Based on an exercise price of $1.38/, illustrate the impact of an options hedge assuming spot rates in 6 months-time of (1) $1.35/ and (2) $1.41/. (15 marks) Explain the main features of option contracts and show the payoff diagram of the option contracts subscribed by the Belgian company. (20 marks)