PPP and Hedging with Call Options
Response to the following problem:
Visor, Inc. (a U.S. firm), has agreed to purchase supplies from Argentina and will need 1 million Argentine pesos in 1 year. Interest rate parity presently exists. The annual interest rate in Argentina is 19 percent. The annual interest rate in the United States is 6 percent. You expect that annual inflation will be about 11 percent in Argentina and 4 percent in the United States. The spot rate of the Argentine peso is $.30. Call options on pesos are available with a 1-year expiration date, an exercise price of $.29, and a premium of $.03 per unit.
Determine the expected amount of dollars that you will pay from hedging with call options (including the premium paid for the options) if you expect that the spot rate of the peso will change over the next year based on purchasing power parity.