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Money market hedge and option market hedge

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Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £20 million payable in one year (i.e., Boeing has a £20 million receivable in one-year). The money market rates, foreign exchange rates, and option prices are given as follows:

The U.S. one-year interest rate: 2% per annum

The U.K. one-year interest rate: 3.5% per annum

The spot exchange rate: $1.32/£

One-year forward rate: $1.2985/£

Call option: exercise rate: $1.31, premium: $0.015/£

Put option: exercise rate: $1.31, premium: $0.02/£

(2) Option Market Hedge:

(a) Should Boeing use a Call or a Put to hedge this exposure?

(b) How much net USD will Boeing receive with an option hedge?

(3) Suppose Boeing's analyst predicts that the exchange rate between USD and UK pound in 1 year is between $1.32/£ and $1.33/£. (To receive full credit, you need to answer the questions qualitatively and quantitatively.)

(a) At which exchange rate will Boeing be indifferent between Money Market Hedge and Option Market Hedge?

Reference no: EM133056202

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