1. An American company will need 100,000 Australian dollars (AUD) in one year for an accounts payable transaction. It wishes to hedge this accounts payable and has the following information available:

• The spot exchange rate is AUD 0.73 i.e. 1 Australian dollar buys 0.73 USD
• The one year forward rate is AUD 0.75 i.e. 1 Australian dollar buys 0.75 USD

• The Australian borrowing rate is 6% p.a.
• The Australian lending rate is 5% p.a
• The US borrowing rate is 8% p.a.
• The US lending rate is 9% p.a.
• One year call option contract for AUD 100,000; strike price USD 0.75, premium is USD 0.03.
• The company forecasts that the spot rate for the Australian dollar in one years time will be AUD 0.77 i.e. 1 Australian dollar buys 0.77 USD. This is the companys best estimate of what the spot rate will be in one years time.

Would the firm be better off with:

1. no hedging;
2. a forward hedge;
3. a money market hedge; or
4. an option hedge? For this choice, you need to first determine whether a call or put option should be undertaken.