You are a U.S.-based importer of bicycles and just bought bicycles for 200,000 from Spain. You owe that amount to the supplier in one year. You are concerned about the amount of dollars you will have to pay for this purchase in one year. Suppose all the following:

Spot exchange rate is $1.01/

Forward exchange rate is $1.10/

U.S. interest rate is 3 % per annum

Interest rate in Europe is 4 % per annum.

Now, based on the above assumptions calculate the following accordingly:

a) Unhedged position: Suppose you do not do anything. In one year, spot rate happens to be$ 1.05/. What will be the total dollar cost of this purchase then?

b) How can you lock in the exact dollar cost of this purchase using forward contracts? Should you agree to buy or sell 200,000 forward in one year's time? What will be total dollar cost of this purchase with forward hedge? Are you subject to exchange rate risk in this case?

c) How can you hedge using money market hedge? Where should you borrow and how much? What is the total dollar cost of this purchase? Are you subject to exchange rate risk in this case?

d) Would you buy call or put options if you want to hedge this exposure using options markets?