An Australian company is to sign a contract for 160 million Korean Won (KW) that will...

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An Australian company is to sign a contract for 160 million Korean Won (KW) that will be paid shortly in the future. Given the current exchange rate of KW1,000 per Australian dollar, this amount is consistent with the company's target of $160,000 million dollars for its services. Assume it is July and that the contract amount will be paid on 30 September. The following September option quotes are available in the market today to help hedge against this exchange rate risk: A call option with a strike of KW1,010 at a premium of KW0.25 ● A put option with a strike of KW1,010 at a premium of KW0.15 Note that the option premiums are quoted in exchange rate terms. The size of each option contract is for one million Won. The board of directors of the company has requested that you answer the following questions: a) Which option and position should be used in this hedging strategy? Using min or max notation, what is the payoff and profit function of the preferred option? b) How many option contracts should the company buy or sell? c) What is the cost of this hedging strategy in Australian dollar terms? d) Assume it is now September and the contract is paid as expected. It is now time to exchange the currency. What is the net cash flow implication of this contract to the company, assuming the Won appreciates to KW800 or depreciates to KW1,200 per Australian dollar? Show all cash flows (in Australian dollar terms) as well as the impact of the hedge in calculating the net cash flow for both scenarios. An Australian company is to sign a contract for 160 million Korean Won (KW) that will be paid shortly in the future. Given the current exchange rate of KW1,000 per Australian dollar, this amount is consistent with the company's target of $160,000 million dollars for its services. Assume it is July and that the contract amount will be paid on 30 September. The following September option quotes are available in the market today to help hedge against this exchange rate risk: A call option with a strike of KW1,010 at a premium of KW0.25 ● A put option with a strike of KW1,010 at a premium of KW0.15 Note that the option premiums are quoted in exchange rate terms. The size of each option contract is for one million Won. The board of directors of the company has requested that you answer the following questions: a) Which option and position should be used in this hedging strategy? Using min or max notation, what is the payoff and profit function of the preferred option? b) How many option contracts should the company buy or sell? c) What is the cost of this hedging strategy in Australian dollar terms? d) Assume it is now September and the contract is paid as expected. It is now time to exchange the currency. What is the net cash flow implication of this contract to the company, assuming the Won appreciates to KW800 or depreciates to KW1,200 per Australian dollar? Show all cash flows (in Australian dollar terms) as well as the impact of the hedge in calculating the net cash flow for both scenarios.

Answer rating: 100% (QA)

a The company should buy the put option with a strike of KW1010 at a premium of KW015 to hedge again... View the full answer