(Ch. 5) Option Hedge. It is October 2022 now. Quality Imports, a U.S.-based importer,

has an Australian dollar (AUD) 300 million payable due in March 2023. Quality Imports

decides to use options to hedge foreign exchange risk. The market quotes for the available

options with March maturity are:

X (strike rate in AUDUSD) AUD Calls / USD Puts AUD Puts / USD Calls

0.62 6.02 0.08

0.67 1.59 1.46

0.70 0.16 3.34

where X represents the strike exchange rate in AUDUSD, the premiums are expressed in

USD cents (i.e., 1.46 equals USD 0.0146), and the option's underlying exchange rate is

based on the value of one unit of the AUD in terms of the USD (or AUDUSD). Today, the

spot exchange rate for AUDUSD is 0.67.

a. If this company wants to hedge by buying an out-of-the-money option, which type

of option (AUD Calls/USD Puts or AUD Puts/USD Calls) with what strike rate

should this company purchase? (5 points) Calculate the premium paid or received

from hedging using options. (3 points) Describe the net cash flows (in USD) in

March for the overall position of this company by analyzing the following two

scenarios: the options are exercised, and the options are not exercised at expiration.

(6 points)

b. Suppose this company can trade AUD forward contracts today at Ft,March(AUDUSD)

= 0.6850. Calculate the cash flows (in USD) in March for this company under this

forward contract. (5 points)

c. What are the pros and cons of the forward contract relative to the options alternative?

(3 points)