Suppose that you (i.e., company XYZ) are a US-based importer of goods from Canada. You expect the value of the Canada to increase against the US dollar over the next 6 months. You will be making payment on a shipment of imported goods (CAD100,000) in 6 months and want to hedge your currency exposure. The US risk-free rate is 5% and the Canada risk-free rate is 4% per year. The current spot rate is $1.25/CAD, and the 6-month forward rate is $1.3/CAD. You can also buy a 6-month option on Canadian dollars at the strike price of $1.4 /CAD for a premium of $0.10/CAD.

1) If XYZ enters a forward contract today, the guaranteed dollar cost for this CAD obligation today (not in six months) should be $______

2) In six months, if the spot exchange rate turns to be $1.4/CAD. XYZ will be _______ using forward hedge compared with unhedged position. a) better off b) worse off c) indifferent

3) If XYZ wants to hedge the transaction exposure using money market hedge, XYZ should ______________. a) borrow PV of CAD and buy USD today, and deposit USD in the bank and sit on it. b) buy PV of CAD today using USD, and deposit CAD in the bank and sit on it.

4) If XYZ uses MMH, the guaranteed dollar cost today should be $_____

5) At what 6-month forward rate: $ /CAD will XYZ be indifferent between the forward hedge and MMH? Please leave 4 decimal points for your answer.

6) If XYZ wants to hedge the transaction exposure using option hedge, XYZ should ______. a) buy a put option b) sell a put option c) buy a call option d) sell a call option

7) If XYZ hedges the exposure using an option hedge, total option premium: $____ will be paid today. The option premium will grow to $_____ in six months at the US interest rate. In six months, if the spot price is $1.3 per CAD, the option is (in or out) of the money. So, XYZ will buy 100,000 CAD at the price of $ per CAD, which equals to a total cost of $____ After the option premium, the total (net) dollar costs in six month is $____

8) At what future spot exchange rate do you think XYZ will be indifferent between the option and forward hedge?

9) The range that you will prefer option hedge to forward hedge is ________.

a) when the future spot rate is higher than the indifference price that you solved in the above question.

b) when the future spot rate is lower than the indifference price that you solved in the above question. 10) Suppose Canada company gave XYZ a choice of paying either CAD100,000 or $125,000 in six months. If the spot exchange rate in six months turns out to be $1.3/CAD, which currency (USD or CAD) do you think XYZ will choose to use for payment? The value of this free option for XYZ is $________ .