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Indifferent between the forward and the option market hedges

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(Transaction Exposure to Currency Risk): You plan to visit Geneva, Switzerland, in three months to attend an International Student Conference. You expect to incur a total cost of CHF 5,000 for lodging, meals, and transportation during your stay. As of today, the spot exchange rate is USD 0.60 / CHF and the three-month forward rate is USD 0.63 / CHF. You can buy a three-month call option on CHF with an exercise price of USD 0.64 / CHF for the premium of USD 0.05 / CHF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per year in USD and 4 percent per year in CHF.

a. Calculate your expected dollar cost of buying CHF 5,000 if you choose to hedge by a call option on CHF.

b. Calculate the future dollar cost of meeting this CHF obligation if you decide to hedge using a forward contract.

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

Reference no: EM131702803

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