Refer to the Instructions below:

Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, OTI is considering several hedging alternatives to reduce the exchange rate risk arising from the sale.

To help the firm make a hedging decision you have gathered the following information.

The spot exchange rate is $1.40/euro The six month forward rate is $1.38/euro OTI's cost of capital is 11% The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) The U.S. 6-month lending rate is 6% (or 3% for 6 months) December call options for euro 625,000; strike price $1.42, premium price is 1.5% OTI's forecast for 6-month spot rates is $1.43/euro The budget rate, or the highest acceptable purchase price for this project, is $3,625,000 or $1.45/euro If OTI chooses NOT to hedge their euro payable, the amount they pay in six months will be ________.

A. $3,500,000 B. $3,450,000 C. 3,450,000 D. unknown today

If OTI chooses to hedge its transaction exposure in the forward market, it will ________ euro 2,500,000 forward at a rate of ________.

A.buy; $1.38. B. buy; $1.40. C. sell; $1.38. D.sell; 1.40.

OTI chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the accounts payable in 6 months will be ________. A.$2,500,000 B.$3,450,000 C.$3,500,000 D.$3,575,000

If OTI locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange accounting transaction ________" of ________.

A.loss; $50,000. B.loss; 50,000. C.gain; $50,000. D.gain; 50,000.

OTI would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct.

A.better off; $125,000 B.better off; 125,000 C.worse off; $125,000 D.worse off; 125,000

What is the cost of a call option hedge for OTI's euro receivable contract? (Note: Calculate the cost in present value dollars.)

A.$52,500 B.$55,388 C.$56,125 D.$58,275