BMC Corporation, an Australian company, has to pay CAD420,000 for an import consignment in six months to a Canadian company.  Depending on its needs, BMC can either borrow or deposit in both the Australian dollar (AUD) and the Canadian dollar (CAD). The existing spot rate of the CAD is AUD 1.2160/CAD. The six-month forward rate of the CAD is AUD 1.2280/CAD. The following additional information has also been provided;                                                 

 Forecasted foreign exchange rates for the next six months under three different scenarios are given below.

Forecast	Probability
AUD 1.1960/CAD	20%
AUD 1.2175/CAD	50%
AUD 1.2425/CAD	30%

       The current commercial banks' annual lending and deposit interest rates are:

	Australia	Canada
Deposit	3.40%	2.50%
Lending	5.24%	3.58%

Assume that 06-Month put options on CAD are available, with an exercise price of AUD 1.1850/CAD and a premium of AUD 0.06 per unit and 6-months call options on CAD are available with an exercise price of AUD 1.2025/CAD and a premium of AUD0.05 per unit.

You are required to:

1. You are required to estimate the cash flow positions of BMC under not-hedge, forward hedge  money market hedge and option hedge and to select the best alternative course of action
2. Explain how the put option contracts can be used to hedge the CAD payables.  (explain, calculations are not required)?

Answer rating: 100% (QA)

The following are the cash flow positions of BMC under the different hedging strategies Not hedge If BMC does not hedge it will be exposed to the risk ... View the full answer