Assume that today is March 7, and, as the newest hire for Goldman Sachs, you must advise a client on the costs and benefits of hedging a transaction with options. Your client (a small U.S. exporting firm) is scheduled to receive a payment of :6,250,000 on April 20, 44 days in the future. Assume that your client can borrow and lend at a 6% p.a. U.S. inter- est rate.
a. Describe the nature of your client's transaction exchange risk.
b. Use the appropriate American option with an April maturity and a strike price of 129¢>: to determine the dollar cost today of hedging the transaction with an option strategy. The cost of the call option is 3.93¢>:, and the cost of the put option is 1.58¢>:.
c. What is the minimum dollar revenue your client will receive in April? Remember to take account of the opportunity cost of doing the op- tion hedge.
d. Determine the value of the spot rate (tiny_mce_markergt;:) in April that would make your client indifferent ex post to having done the option transaction or a forward hedge. The forward rate for delivery on April 20 is $1.30>:.