The European construction company Imperial has bid for a Japanese road-building contract. If Imperial wins, the project will generate 15bn of revenue in 18 months. To hedge this position, Imperial decides to buy a put option on the Yen for the 15bn bid amount. The put option matures in eighteen months. The strike price is 196.45 / . In order to reduce its hedging costs, Imperial also decides to sell a call option for 15bn with the same strike price of 196.45 / and the same maturity. The premia for the two contracts are the same. The current spot rate is 201.13/. This is an example of a contingent exposure, in the sense that the exposure to forex risk depends (is contingent) on the outcome of a bid. Analyze and discuss Imperials decision in that context. You need to look at both possible outcomes of the bid, the case in which Imperial wins the bid and the case in which it doesnt win.

(i) Assume first that Imperial wins the bid. Draw a graph illustrating the strategies available to Imperial in this case, including a comparison with the unhedged position. Show on the X- axis some relevant spot exchange rates and on the Y-axis the associated revenue. Discuss the choice.

(ii) Assuming there are no arbitrage opportunities, what is the forward exchange rate?

(iii) Assume now that Imperial does not end up winning the bid. Draw a graph to illustrate the payoffs of the derivatives strategies in this case. Explain.