A US company will need 100,000 Australian dollars (AUD) in one year for an accounts payable transaction.
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Question:
- A US company will need 100,000 Australian dollars (AUD) in one year for an accounts payable transaction. It wishes to hedge this accounts payable and has the following information available:
- The spot exchange rate is AUD 0.73 i.e. 1 Australian dollar buys 0.73 USD
- The one-year forward rate is AUD 0.75 i.e. 1 Australian dollar buys 0.75 USD
- The Australian borrowing rate is 6% p.a.
- The Australian lending rate is 5% p.a
- The US borrowing rate is 8% p.a.
- The US lending rate is 9% p.a.
- One year call option contract for AUD 100,000; strike price USD 0.75, the premium is USD 0.03.
- The company forecasts that the spot rate for the Australian dollar in one years’ time will be AUD 0.77 i.e. 1 Australian dollar buys 0.77 USD. This is the company’s “best” estimate of what the spot rate will be in one years’ time.
Would the firm be better off with:
- no hedging;
- a forward hedge;
- a money market hedge; or
- an option hedge? For this choice, you need to first determine whether a call or put option should be undertaken.
Show workings for each of the choices listed above.
Related Book For
Managerial Accounting
ISBN: 978-0078025518
2nd edition
Authors: Stacey Whitecotton, Robert Libby, Fred Phillips
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