1. You plan to visit Germany in six months to negotiate a retail contract with a company located in Munich. You expect to incur a total cost of 10,800 for lodging, meals and transportation.

Current spot exchange rate: $0.70 /

Six-month forward rate: $0.78 /

Six-month call option on euros has exercise rate: $0.82 /

Premium on six-month call option: $0.03 /

Expected future spot exchange rate: same as the forward rate

Six-month interest rate in U.S.: 3.5% per annum

Six-month interest rate in Germany: 1.5% per annum

1. Calculate your expected dollar cost of buying 10,800 if you hedge via a call option on euros.
   1. First calculate the FV of the call premium
   2. Next, at the expected future spot rate would you exercise the option?
   3. To find your expected dollar cost: If you would not exercise, then total expected dollar cost is the FV of the premium plus the cost exchanged at the future spot rate. If you would exercise the option, then the total expected dollar cost would equal the FV of the premium plus the cost exchanged at the option exercise price.

(b) Calculate the future dollar cost of meeting this euro obligation if you hedge using a forward contract.

(c) At what future spot exchange rate will you be indifferent between the forward and option market hedges?

(d) Illustrate the future dollar costs of meeting the euro payable against the future spot exchange rate under both the options and forward market hedges. Graph $ Cost on the Y-axis and $ / on X-axis.