Tracero is concerned that sudden exchange rate volatility could pressure operating results and endanger covenants on a debt issue floated two years ago. The company does not want to hedge all revenue and costs but would like to significantly reduce exchange rate volatility and its effects on reported results. The treasurer and CFO of the company have focused their attention on Europe and hence the Euro as the majority of its business is centered in that region of the world. You have been hired to develop a foreign exchange strategy for Tracero which will significantly reduce its overall currency risk and exposure.

3) What is the net Euro exposure?

4) detail how you would hedge the foreign currency risks stipulated above through multiple strategies which must include:

a) Forward contracts

b) Futures contracts

c) Option contracts

5) Explain the logic of hedging the net Euro exposure instead of gross Euro revenues:

6) Explain why Tracero might find hedging with futures contracts to be less desirable than hedging with a forward contract.

7) Detail the Forward Contract hedging strategy for Tracero

8) Given the following data, detail the hedging strategy using Futures Contracts

Contract: September 2022 Euro Futures Contract @ $1.2496

Size of Contract: 125,000 Euros

9) Given the following data, detail the hedging strategy using Options Contracts

Contract: Euro September $1.25 Puts @ $.0255/Euro

Size: 125,000 Euros

10) If the cost of capital is 11.5675%, what is the cost to Tracero of the option strategy?

11) What are the fundamental differences for Tracero between hedging with forward and futures contracts and hedging with option contracts.

12) What is the break-even spot rate between the forward and option strategies?

13) Give a description of when the use of options may be favored for Tracero as opposed to a forward contract strategy. In addition, give the downside to the use of options.