1. Draw an exposure diagram to illustrate a firm’s exposure tointerest rate risk if the firm is going to borrow $10m six monthsfrom today. Assume the loan will be a one-year loan with allinterest paid at the end of the year. Graph the relation betweenthe firms interest costs and interest rates. Also graph therelation between the firm’s profit and interest rates (assumingthat higher interest costs cannot be passed on the consumers).

2.Draw an exposure diagram to illustrate the relationshipbetween a firm’s costs and the exchange rate between US dollar andEuro dollar if the fir plans to purchase goods from an Europeanfirm one year from today. Assume that the transaction isdenominated in Euro dollar, but that the firm is concerned aboutits costs in US dollars. Also draw an exposure diagram toillustrate the relationship between a firm’s profit and theexchange rate between US dollar and Euro dollar.

3. Draw an exposure diagram to illustrate the relationshipbetween a gold mining firm’s profit and the price of gold in threemonths.

4. Would a call option or a put option hedge the exposure of thefirms described in problem 1,2 and 3?

5. Would a long (buy) or a short (sell) forward position hedgethe exposure of the firms described in problem 1,2 and 3?