a)A large corporation located in the United States has an accounts payable obligation of 700 million payable
Question:
a)A large corporation located in the United States has an accounts payable obligation of 700 million payable in one year to a bank in Osaka, Japan. The current spot rate is 115/$ and the one year forward rate is 110/$ (where $ refers to USD).The annual interest rate is 3.5 percent in Japan and 5.5 percent in the United States.Would the firm be better off with a forward hedge or a money market hedge?Show workings for each.(5 marks)
b)Harrison Brothers Ltd, a firm based in the US, transported goods to Australia and will receive 2 million Australian dollars in 3 months. It believes the 3 month forward rate will be an accurate forecast of the future spot rate. The 3 month forward rate of the Australian dollar is USD 0.78 i.e. 1 AUD is buying $0.78 USD. A put option contract for 2 million Australian dollars is available with an exercise price of $0.82 and a premium of $0.03. Would Harrison Brothers prefer a put option hedge to no hedge? If a put option hedge is recommended, compare the outcome with the no hedge strategy using any relevant calculations. If no put hedge is recommended, provide an explanation as to why this is so in no more than 1- 2 sentences (60 words maximum) and show, with calculations, what the no hedge outcome is likely to be.(5 marks)