your firm purchased a stock of guacamole for 250,000 mexican peso (MEP) and promised to repay in 3 months. You are not sure whether to hedge or not your exposure. Therefore, you asked your employees in the finance division to come up with an estimate of the future spot exchange rate, E[S(NOK/MEP)]. After days of hectic work they tell you that the internal model to forecast future spot exchange rates gave E[S(NOK/MEP)] = NOK/MEP 2.30.

1. a) Show detailed steps of the hedging strategy using a forward and compute the cost in NOK for the firm to meet its obligation. The forward rate is F(NOK/MEP) = NOK/MEP 2.25. Would you hedge your exposure?

(30 points) Detail a hedging strategy using (a portfolio of) options that exactly replicates the cash flows of the hedging strategy with the forward that you computed in exercise 2-part a). Use the two following options to construct the portfolio: Mexican peso European options, maturity 3 months Premium Listed options Put Call - Strike price: NOK/MEP 2.25 NOK/MEP 0.001 NOK/MEP 0.001 Hint: Assume two scenarios as we did in class. One in which the spot rate at maturity is less than strike price, S(NOK/MEP) = 2.15, and one in which is higher than strike, S(NOK/MEP) = 2.35. Show how the cash flows at maturity of the portfolio coincide with those of the forward. (30 points) Detail a hedging strategy using (a portfolio of) options that exactly replicates the cash flows of the hedging strategy with the forward that you computed in exercise 2-part a). Use the two following options to construct the portfolio: Mexican peso European options, maturity 3 months Premium Listed options Put Call - Strike price: NOK/MEP 2.25 NOK/MEP 0.001 NOK/MEP 0.001 Hint: Assume two scenarios as we did in class. One in which the spot rate at maturity is less than strike price, S(NOK/MEP) = 2.15, and one in which is higher than strike, S(NOK/MEP) = 2.35. Show how the cash flows at maturity of the portfolio coincide with those of the forward