## Monetary economics

Assume the spot rate of the â‚¤ is $1.7000. The British interest rate is 10%, and the U.S. interest rate is 11% over the 360 day (1 year) period. The British inflation rate is 4% and the U.S. inflation rate is 3.5% over the 360-day (1 year) period. The 180-day forward price is $1.7200/â‚¤. The 180-day European call option on the $ with the exercise price of â‚¤0.5800 is selling at 3% premium, while the 180-day European put option on the $ with the exercise price of â‚¤0.5900 is selling at 2% premium. Your U.S. based firm has an account payable of â‚¤200,000 due in 180 days.

A) What should be the 180-day forward rate based on Interest Rate Parity (IRP)?

What is the dollar cost of using a forward hedge? Make sure you state your position in the forward contract. (4 marks)

B) Assume the firm has no excess cash. Use the above to calculate the dollar cost of using a money market hedge to hedge â‚¤200,000 of payable due in 180 days?

(6 marks)

C) Calculate the cost of an option hedge at the time the payment is due assuming you exercise the option when the payment is due. (6 marks)

D) Based on the answers in (a), (b), and (c), which hedging methods should your firm choose? (4 marks)