A US-Based Corporation Has Decided to Make an Investment in Norwegian

Multiple Choice

A US-based corporation has decided to make an investment in Norwegian Kroner of NOK 500 Million (NOK = Norwegian Kroner) in 3 months. The company wishes to hedge changes in the the US dollar-NOK exchange rate using forward contracts on either the euro (EUR) or the Swiss Franc (CHF) . The company makes the following estimates:
-If EUR forwards are used: The standard deviation of quarterly changes in the USD/NOK spot exchange rate is 0.005, the standard deviation of quarterly changes in the USD/EUR forward rate is 0.025, and the correlation between the changes is 0.90.
-If CHF forwards are used: The standard deviation of quarterly changes in the USD/NOK spot exchange rate is 0.005, the standard deviation of quarterly changes in the USD/CHF forward rate is 0.020, and the correlation between the changes is 0.80.
The current USD/NOK spot rate is 0.160 (i.e., USD 0.160 per NOK) , the current 3-month USD/EUR forward rate is 1.36, and the current 3-month USD/CHF forward rate is 1.04.
If the company wishes to carry out a minimum-variance hedge, which currency should it use for this purpose?

A) CHF, because the forward exchange rate of near 1 makes it "more" like the USD.
B) EUR, because Norwegian trade with the eurozone countries far exceeds its trade with Switzerland.
C) EUR, because of the higher correlation of 0.90.
D) CHF, because of the lower correlation of 0.80.