00:04
Hi, in today's question, we are going to discuss one important topic of financial economics.
00:10
So before solving this question, you need to understand some important concepts of financial economics, which are related to exchange rate.
00:20
So first of all, what is an exchange rate? exchange rate is a relative price of one currency expressed in terms of other currency.
00:48
The second key point you need to understand is a call option.
01:11
A call option is a contract between buyer and seller wherein they purchase a certain stock at a certain price up until a defined expiration date.
02:11
And the third term you need to understand is hedging.
02:15
Hedging is a way of protecting oneself from some financial risk or losses.
02:37
This is usually done with the help of diversification in our portfolio.
03:00
Now looking at the question, it is stated that you plan to visit geneva, switzerland in three months to attend an international business conference.
03:19
You expect to incur a total cost of around sf 5000 for lodging, meals and transportation during this time.
03:29
As of today, the current exchange rate is at $60 .60 sf and the three month forward rate is at 0 .63 sf.
03:45
You can buy the three month call option on sf with an exercise rate of 0 .64 sf at a premium of 0 .05 per sf.
04:11
Now let's assume the future spot exchange rate is same as the forward rate.
04:16
The three month interest rate is also available to us as 6%.
04:21
It is the three month forward rate.
04:28
Three month interest rate.
04:30
Now in this question, we are required to find the expected dollar cost of buying $5000 if we choose to hedge by a call option on sf.
04:57
Second, we need to calculate the future dollar cost of meeting this sf obligation if we decide to hedge using the forward contract...