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You believe that IRP presently exists. The nominal annual interest rate in Mexico is 13%. The nominal annual interest rate in the U.S. is 4%. You expect that annual inflation will be about 4% in Mexico and 4.5% in the U.S. The spot rate of the Mexican peso is $.10. Put options on pesos are available with a one-year expiration date, an exercise price of $.1008, and a premium of $0.014 per unit.

You will receive 1 million pesos in one year.

a. Determine the amount of dollars that you will receive if you use a forward hedge.

b. Determine the expected amount of dollars that you will receive if you do not hedge and believe in purchasing power parity (PPP).

c. Determine the amount of dollars that you will expect to receive if you use a currency put option hedge. Account for the premium you would pay on the put option.

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Trinidad Tremblay
Trinidad TremblayLv2
28 Sep 2019

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Kanab Co. and Zion Co. are U.S. companies that engage in much business within the U.S. and are about the same size. They both conduct some international business as well.

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You are evaluating a project and are trying to determine the cash flows in dollars your firm needs to receive in five years to accept the project. The necessary information is:

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Mexican interest rates are normally substantially higher than U.S. interest rates.

a. What does this imply about the inflation differential (Mexico inflation minus U.S. inflation), assuming that the peso interest rate is the same in both countries? Does this imply that the Mexican peso will appreciate or depreciate? Explain.

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