Airbus just signed a contract to sell an A380 aircraft to Delta and Delta will be billed €150,000,000 which is payable in one year. Delta is concerned about currency risk from its euro exposure and is considering three hedging alternatives: forward hedge, money market hedge, and option hedge.
The current spot exchange rate is quoted at $1.28/€ and the one-year forward exchange rate is quoted at $1.29/€. Currently, one-year money market rates are 4% in the U.S and 3.5% in the euro zone. A one-year call option on euros with a strike or exercise price of $1.27/€ is selling at a premium of $0.03 per euro.
A. Compute the expected dollar cost of securing the euros if Delta decides to hedge using a forward contract.
B. What transactions would Delta need in order to carry out a money market hedge? Compute the guaranteed dollar cost of securing the euros if Delta decides to use a money market hedge.
C. At what forward exchange rate will Delta be indifferent between the forward hedge and the money market hedge?
D. Compute the expected dollar cost of securing the euros if Delta decides to hedge using call options on euros. Assume that Delta regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate one year from now.
E. At what future spot exchange rate do you think Delta will be indifferent between the option hedge and forward hedge?