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In 6-month from today, a U.S. based company will receive 2,000,000 Australian dollars (AUD) and the company wants to hedge the exchange rate risk. The expected AUD spot rate in 6-month will either appreciate by 5% (p.a) with 40% probability or depreciate by 10% (p.a.) with 60% probability. All rates are continuous compounding (please round your answers to 4 decimals in the exchange rate calculations) As the financial manager of the company, you look at Bloomberg and collect the following information: • U.S. interest rate: . 4% p.a. 5% p.a. 1 AUD=0.63 USD Spot rate: Call option premium 0.03 USD, with exercise exchange rate 1 AUD-0.65 USD and 6-month maturity Australian interest rate: ISD

In 6-month from today, a U.S. based company will receive 2,000,000 Australian dollars (AUD) and the company wants to hedge the exchange rate risk. The expected AUD spot rate in 6-month will either appreciate by 5% (p.a) with 40% probability or depreciate by 10% (p.a.) with 60% probability. All rates are continuous compounding (please round your answers to 4 decimals in the exchange rate calculations) As the financial manager of the company, you look at Bloomberg and collect the following information: • U.S. interest rate: . 4% p.a. 5% p.a. 1 AUD=0.63 USD Spot rate: Call option premium 0.03 USD, with exercise exchange rate 1 AUD-0.65 USD and 6-month maturity Australian interest rate: ISD

International Financial Management
International Financial Management
14th Edition
ISBN:9780357130698
Author:Madura
Publisher:Madura
Chapter11: Managing Transaction Exposure
Section: Chapter Questions
Problem 40QA
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Question 2 In 6-month from today, a U.S. based company will receive 2,000,000 Australian dollars (AUD) and the company wants to hedge the exchange rate risk. The expected AUD spot rate in 6-month will either appreciate by 5% (p.a) with 40% probability or depreciate by 10% (p.a.) with 60% probability. All rates are continuous compounding (please round your answers to 4 decimals in the exchange rate calculations). As the financial manager of the company, you look at Bloomberg and collect the following information: • U.S. interest rate: . . 4% p.a. 5% p.a. 1 AUD=0.63 USD Spot rate: Call option premium 0.03 USD, with exercise exchange rate 1 AUD-0.65 USD and 6-month maturity Put option premium 0.02 USD, with exercise exchange rate 1 AUD-0.64 USD and 6-month maturity Australian interest rate: 1) Calculate the 6-month forward exchange rate, describe how a forward agreement can be used to hedge the receivable money, and calculate the resulting amount of USD in 6 months.
Transcribed Image Text:Question 2 In 6-month from today, a U.S. based company will receive 2,000,000 Australian dollars (AUD) and the company wants to hedge the exchange rate risk. The expected AUD spot rate in 6-month will either appreciate by 5% (p.a) with 40% probability or depreciate by 10% (p.a.) with 60% probability. All rates are continuous compounding (please round your answers to 4 decimals in the exchange rate calculations). As the financial manager of the company, you look at Bloomberg and collect the following information: • U.S. interest rate: . . 4% p.a. 5% p.a. 1 AUD=0.63 USD Spot rate: Call option premium 0.03 USD, with exercise exchange rate 1 AUD-0.65 USD and 6-month maturity Put option premium 0.02 USD, with exercise exchange rate 1 AUD-0.64 USD and 6-month maturity Australian interest rate: 1) Calculate the 6-month forward exchange rate, describe how a forward agreement can be used to hedge the receivable money, and calculate the resulting amount of USD in 6 months.
2) If the 6-month forward exchange rate is 1 AUD-0.65 USD, is there any arbitrage opportunity? If so, construct an arbitrage strategy based on 2,000,000 AUD in 6-month time and identify the arbitrage profit. 3) Describe how an option can be used to hedge the receivable and calculate the expected amount of USD received in 6 months. 4) Calculated the expected exchange rate and the expected amount of USD received without hedging. Based on the above analysis, compare the effectiveness of no-hedging, forward, and option hedging strategies and outline their differences, advantages, and disadvantages.
Transcribed Image Text:2) If the 6-month forward exchange rate is 1 AUD-0.65 USD, is there any arbitrage opportunity? If so, construct an arbitrage strategy based on 2,000,000 AUD in 6-month time and identify the arbitrage profit. 3) Describe how an option can be used to hedge the receivable and calculate the expected amount of USD received in 6 months. 4) Calculated the expected exchange rate and the expected amount of USD received without hedging. Based on the above analysis, compare the effectiveness of no-hedging, forward, and option hedging strategies and outline their differences, advantages, and disadvantages.
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