In 6 months from today, Delta Inc., a U.S. based company, will receive 2,000,000 Australian dollars (AUD) and the company want to maximize the U.S. dollar value of this money. The expected AUD spot rate in 6-month will either appreciate by 10% (p.a) with 40% probability or depreciate by 5% (p.a.) with 60% probability. All rates are continuous compounding.

As the financial manager of the company, you look at Bloomberg and collect the following information: U.S. interest rate: 1.5% p.a. Australian interest rate: 3.5% p.a. Spot rate: 1 AUD=0.63 USD Call option premium 0.03 USD, with exercise exchange rate 1 AUD=0.65 USD and 6-month maturity Put option premium 0.02 USD, with exercise exchange rate 1 AUD=0.64 USD and 6-month maturity (1) Calculate the 6-month forward exchange rate, describe how a forward agreement can be used to hedge the receivable money, and calculate the resulting amount of USD in 6 months. If the 6- month forward exchange rate is 1 AUD=0.65 USD, is there any arbitrage opportunity? If so, construct an arbitrage strategy based on 2,000,000 AUD in 6-month time and identify the arbitrage profit. (15 marks) (2) Describe how an option can be used to hedge the receivable and calculate the expected amount of USD received in 6 months. Compare the forward and option hedging strategies with respect to their differences, advantages or disadvantages.