a2 Milk Ltd Pty.

a2 Milk is an Australian company specialising in producing fresh milk and milk formula. The company has its operations in Australia. Therefore, there expenses are generally invoiced in Australian dollars (AUD). However, it has recently imported supplies from New Zealand, and the bill is invoiced in the New Zealand dollars (NZD) for NZD 1,500,000, payable in 6 months time.

Suppose a2 Milks management is concerned about foreign exchange rate exposure, and would like to hedge this risk. Suppose also that you observe the following quotes in the foreign exchange market:

Currency		In USD	Per USD
AUD	Spot	0.7289	1.3719
	1-month forward	0.7280	1.3736
	3-month forward	0.7264	1.3767
	6-month forward	0.7242	1.3808
NZD	Spot	0.6759	1.4795
	1-month forward	0.6763	1.4786
	3-month forward	0.6785	1.4738
	6-month forward	0.6800	1.4706

The banker offers to set up a forward hedge based on the NZD/AUD forward cross-exchange rate implicit in the forward rates against the dollar. Suppose you are a risk manager at a2 Milk. You are required to advise the CEO the following:

1. The foreign exchange rate risk exposure of this transaction. (10 marks) (Could you explain in details and step by step)