Plot your profits in one year from the contract as a function of the exchange rate in one year, for exchange rates from 0.75 CAD/EUR to 1.50CAD/EUR. Label this line “Unhedged Profits.”

You are a broker for frozen seafood products for Choice Products. You just signed a deal with a Belgian distributor. Under the terms of the contract, in one year you will he king crab is 110,000 CAD. All cash flows occur in exactly one year.

a. Plot your profits in one year from the contract as a function of the exchange rate in one year, for exchange rates from 0.75 CAD/EUR to 1.50CAD/EUR. Label this line “Unhedged Profits.”

b. suppose the one-year forward exchange rate is 1.25 CAD/EUR. Suppose you enter into a forward contract to sell the EUR you will receive at this rate. In the figure from part (a), plot your combined profits from the crab contract and the forward contract as a function of the exchange rate in one year. Label this line “Forward Hedge.”

c. Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy EUR at a strike price of 1.25 CAD/EUR is trading for 0.10 CAD/EUR. Similarly, a one-year put option to sell EUR at a strike price of 1.25 CAD/EUR is trading for 0.10 CAD/EUR. To hedge the risk of your profits, should you buy or sell the call or the put?

d. In the figure from parts (a) and (b), plot your “all in” profits using the option hedge (combined profits of crab contract, option contract, and option price) as a function of the exchange rate in one year. Label this line “Option Hedge.” (Note: You can ignore the effect of interest on the option price.)

e. Suppose that by the end of the year, a trade war erupts, leading to a European embargo on North American food products. As a result, your deal is cancelled, and you don’t receive the EUR or incur the costs of procuring the crab. However, you still have the profits (or losses) associated with your forward or options contract. In a new figure, plot the profits associated with the forward hedge and the options hedge (label each line). When there is a risk of cancellation, which type of hedge has the least downside risk? Explain briefly.

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