Money Market Versus Call Option Hedging. You expect that inflation in the United States will be 3%, versus 5% in the United Kingdom. The expected spot rate in one year is $1.8756. The spot rate of the pound as of today is $1.8000. The annual interest rate in the United States is 6% versus an annual interest rate in the United Kingdom of 8%. Call options are available with an exercise price of $1.79, an expiration date of one year from today, and a premium of $.03 per unit. Your firm in the United States expects to need 1 million pounds in one year to pay for imports. Use theunhedged strategy, money market hedge and the call option hedge to deal with the exchange rate risk. Estimate the dollar cash flows you will need as a result of an each strategy. (So there should be three separate answers for each cash flow).
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