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I need some help on the following question. Thank you.

Suppose the dollar-euro spot rate is 1.20 and the current 30-day forward
rate is 1.25.
(a) You have an obligation to pay a French supplier of wine 10 million euros in 30 days and have contracted with a U.S. distributor to sell the wine for USD 13 million. How many dollars can you make if you hedge your risk using the forward market?

(b) Is it possible that you could lose money if you do not hedge your risk?

(c) Suppose that you could get a call option that would allow you to buy
euros in 30 days at 1.27. Describe the merits of buying this option relative
to using the forward market as in (a).

(d) Now suppose you are a speculator facing the same spot and forward rates
as above and you have USD 1 million. Suppose you bought euros forward. In 30
days, the spot rate for the dollar turns out to be 1.3. How many dollars did you make or lose from this transaction?

(e) Now suppose instead that the spot rate stayed at the same over the next
30 days. If you bought euros forward, how many dollars did you make or lose
from this transaction?

  • econ -

    Think it through. $1.25 = E1 30-day forward. So to buy 10 million E 30 days from now, to hedge it will cost $12.5 million, profit=$0.5 million

    b) absolutely

    c) This call option says that 30 days from now, you have the option of buying euros at $1.27. If the spot market is above $1.27 you will exercise (use) this option, if below you will not. The will certainly be some kind of up-front fee for getting this option.

    d) and e) take it from here.

  • econ -

    for d) is it 0.3 million profit because you will exercise the option

    for e) is it 0.5 million profit

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