Vegas Mining Productions of Nevada, USA, has just signed a contract to buy a mining equipment to Ottawa Industries of Canada for C$ 5,000,000.

The purchase was made in November with payment due six months later in May.

Vegas CEO, Maria Gonzales, is considering hedging strategies to reduce the exchange rate risk arising from the purchase.

To help the CEO make a hedging decision you, Director of Finance, have gathered the following information:

• The spot exchange rate is C$ 1.23/$
• Vegas weighted cost of capital is 10%

• The C$ annual borrowing rate is 8% while the annual investment rate is 4%
• The US$ annual borrowing rate is 9% while the annual investment rate is 6%
• May C$ 5,000,000 forward rate = C$ 1.27/$
• May C$ 5,000,000 put option:

• Strike price $ 0.8/C$; premium = $ 0.012/C$

• May C$ 5,000,000 call option:

• Strike price $ 0.8/C$; premium = $ 0.02/C$

1. Forward Hedge:

A. Briefly explain (2 3 sentences) whether you should buy or sell a forward to hedge.

(5 points)

B. What is the cost ($) for the C$ 5,000,000 payment with a forward hedge? (5 points)

2. Money Market Hedge:

A. Briefly explain (2 3 sentences) which currency you should invest in or borrow to execute a money market hedge. (5 points)

B. How much should you invest in or borrow? (5 points)

C. What is the cost ($) for the C$ 5,000,000 payment? (15 points)

3. Option Hedge:

A. Briefly explain (2 3 sentences) whether you should buy a put or call option. (5 points)

B. Determine the total premium cost. (5 points)

C. What is the cost ($) for the C$ 5,000,000 payment with an option hedge in May if the exchange rate becomes (i) C$ 1.1/$; (ii) C$ 1.4/$? (25 points)