Dr  Thomas Zhou is planning to buy an 19th century Mittenwald violin for his son Victor in six months from an online store in Munich, Germany, the price will be €20,000

Dr  Thomas Zhou is planning to buy an 19th century Mittenwald violin for his son Victor in six months from an online store in Munich, Germany, the price will be €20,000. The six-month forward rate is $1.207€. Currently he can buy the six-month call option on Euro with an exercise price of $1.25/€ for the premium of $0.04 per Euro. Six month interest rate in US is 2%, i.e. r = 2% per six month.

1. If Thomas chooses to hedge using a forward contract, what is the future dollar cost of this violin? (10)

2. If he decides to hedge with a call option on Euro, what is the total expected future dollar costs of this option hedging strategy on buying €20,000, assuming that the expected future spot exchange rate is the same as the forward rate, i.e. S6= $1.20/€. ? (10)

3. At what future spot exchange rate will Thomas be indifferent between the forward and option market hedges?