Forward versus Option Hedge As treasurer of Tempe Corp., you are confronted with the following problem. Assume the 1-year forward rate of the British pound is $1.59. You plan to receive 1 million pounds in 1 year. A 1-year put option is available. It has an exercise price of $1.61. The spot rate as of today is $1.62, and the option premium is $.04 per unit. Your forecast of the percentage change in the spot rate was determined from the following regression model:
The regression model was applied to historical annual data, and the regression coefficients were estimated as follows
Assume last year’s inflation rates were 3 percent for the United States and 8 percent for the United Kingdom. Also assume that the interest rate differential (DINTt) is forecasted as follows for this year
Using any of the available information, should the treasurer choose the forward hedge or the put option hedge? Show your work.