A company enters into a 1-year forward contract to sell $100 for AUD150. The contract is initially at the money. In other words, the forward exchange rate is 1.50. The 1-year dollar risk-free rate of interest is 5% per annum. The 1-year dollar rate of interest at which the counterparty can borrow is 6% per annum. The exchange rate volatility is 12% per annum. Estimate the present value of the cost of defaults on the contract? Assume that defaults are recognized only at the end of the life of the contract.

AppendixLO1