Tate Inc. places an order to purchase a machine from an Italian firm, Breville Inc., Tate and Breville agree on a transaction price of 350,000 that will be transferred in two years.

1. Tate considers a forward contract to hedge against the currency fluctuations. The current two-year Euro-Dollar forward exchange rate is 0.92/$. If Breville agrees to the forward contract, how much will it cost (in dollars) for Tate to purchase 350,000 in two years?

(4 marks)

2. The Euro-Dollar spot exchange rate today is 0.90/$, and the dollar-denominated risk-free rate is 2.5% per year, while the euro-denominated risk-free rate is 3% per year. Should Tate enter the forward contract with the forward rate of 0.92/$ or pursue a cash-and-carry strategy?

(4 marks)

3. Tate considers a currency option instead of the forward contract. Which option should Tate purchase a call or put option?

(2 marks)

4. What is the price (in dollars) Tate is willing to pay for the option selected in Part C, if it uses Black Scholes option pricing? The $/ exchange rate has 40% volatility and the strike price of the option is $1.10/. Take the forward exchange rate from (a) and the spot exchange rate and the interest rates from (b).