The following is a comprehensive hedging problem. Suppose today is January 2 and BSK, Inc. is a US firm that has the following Canadian dollar (CAD) and Australian dollars (AUD) cash flows due in 6 months (July 2):

Receivables Payables

Canadian dollar CAD2,000,000 CAD1,735,000

AUD AUD 2,765,000 AUD 3,700,000

Suppose also you have the following information regarding foreign exchange rates, interest rates, and futures and options prices, all reported as of January 2:

Bid Ask

Spot: CAD 1.2605/$ CAD 1.2610/$

AUD 1.3610/$ AUD 1.3615/$

6-mo forward CAD 1.2673/$ CAD 1.2682/$

AUD 1.3500/$ AUD 1.3515/$

Annualized interest rates on 6-month deposits and 6-month loans:

Deposit Lending

US 2.35 2.45

Canada 2.80 2.90

Australia 1.50 1.58

Assume Futures Prices on Jan 2 $/CAD $/AUD

Sept. futures (futures matures on September15) $0.7880/CAD $0.7420/AUD

(1 CAD contract = CAD 100,000; 1AUD contract = AUD100,000, both maturing in September, and one cannot go long or short fractions of a contract)

Options market prices on Jan. 2, (Note: Quotes below are in US cents/1FX on Sept. Contracts):

Call Prem Put Prem

Sept option on CAD w/ 80 strike 1.17 1.45

Sept option on AUD w/74 strike 1.14 1.90

(Suppose 1 CAD options contract = CAD50,000; 1AUD options contract = 50,000 AUD, and assume one cannot buy fractions of the options contracts)

a. What is the firms net exposure in each currency? How would currency correlations (in general) affect your assessment of the firms total exposure to exchange risk?

b. Suppose BSK, Inc. wishes to hedge its net foreign exchange rate exposure in each currency with forward hedges (that is, regardless of your answer to (a), it plans on hedging its net exposure in CAD and AUD separately). What will the firm pay or receive (number of $) for CAD and AUD 6 months from Jan.2 (i.e. on July 2) if it hedges its risks in the forward market?

c. Suppose instead the firm considers hedging its net foreign exchange exposures in each currency with money market hedges. What will the firm pay or receive (number of $) for CAD and AUD 6 months from Jan.2 (i.e. on July 2) if it hedges its risks using money market hedges (given the data provided in the problem)?