11 Hogan plc exports computer components valued at 28 million Australian dollars (AUD) to Dundee Proprietary in Australia on three months credit. The current spot exchange rate is A$2.80 vs. Because of recent volatility in the foreign exchange markets, Hogan’s directors are worried that a fall in the AUD could wipe out their profits on the deal. Three alternative hedging strategies have been suggested:

(i) using a forward market hedge

(ii) using a money market hedge

(iii) using an option hedge.

Hogan’s treasurer discovers the following information:

■ The three-month forward rate is A$2.805 vs. £1

■ Hogan could borrow in AUD at 9 per cent interest (annual rate), and deposit in London at 7 per cent.

■ A three-month American put option to sell A$28 million at an exercise rate of A$2.81 vs. £1 could be purchased at a premium of £200,000 on the London OTC option market.

Required Show how each hedge would operate, assuming the following spot rates apply in three months’ time:

Transcribed Image Text:

(a) A$2.78 vs. 1 (b) A$2.82 vs. 1.