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DKNY owes 7 million Mexican pesos in 30 days for a recent shipment from Mexico. It faces the following interest and exchange rates:
Spot rate: 13.0 pesos/$
Forward rate (30 days): 13.1 pesos/$
30-day call option on pesos: strike price E=1/12.9=0.07752 $/peso
Premium: 0.00077 $/peso
U.S. dollar 30-day interest rate (annualized): 7.5%
Peso 30-day interest rate (annualized): 15%
(a) What dollar cost of the payable can DKNY lock in using the forward contract?
(b) What is the hedged dollar cost of DKNY’s payable using a money market hedge?
(c) What is the hedged dollar cost of DKNY’s payable using a call option?
(d) Suppose that DKNY expects the 30-day spot rate to be 13.4 pesos/$. Should it hedge this payable?
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