An Australian company is expected to pay 10 million euros in 6 months and would like...

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An Australian company is expected to pay 10 million euros in 6 months and would like to hedge its exposure to exchange rate risk. The following instruments are available - a 6 months forward contract with forward price 1.40, a European call option with a strike of $1.40, and a European put option with at strike of $1.40. The premium cost is $0.0411 for calls and puts. The cost of financing is 0% p.a., continuously compounded. Describe the best hedging strategy and draw the payoff diagram for each of the following scenarios. a) The company wants to completely eliminate its exposure to foreign exchange rate risk. (2 marks) b) The company wants to eliminate any downside risk if the exchange rate increases, while keeping the upside opportunity to gain if the exchange rate declines. (2marks) c) The company is happy to sell the upside opportunity to gain when the exchange rate decreases, while keeping the downside risk if exchange rate increases. (2 marks) An Australian company is expected to pay 10 million euros in 6 months and would like to hedge its exposure to exchange rate risk. The following instruments are available - a 6 months forward contract with forward price 1.40, a European call option with a strike of $1.40, and a European put option with at strike of $1.40. The premium cost is $0.0411 for calls and puts. The cost of financing is 0% p.a., continuously compounded. Describe the best hedging strategy and draw the payoff diagram for each of the following scenarios. a) The company wants to completely eliminate its exposure to foreign exchange rate risk. (2 marks) b) The company wants to eliminate any downside risk if the exchange rate increases, while keeping the upside opportunity to gain if the exchange rate declines. (2marks) c) The company is happy to sell the upside opportunity to gain when the exchange rate decreases, while keeping the downside risk if exchange rate increases. (2 marks)

Answer rating: 100% (QA)

To determine the best hedging strategy for the Australian company and draw the payoff diagrams for the given scenarios we need to analyze each scenario separately Lets break down each scenario a The c... View the full answer