Forward strategy for currency hedging

Wellvet Partners is renowned for its provision of currency hedging services to international clients. Recently, Square Corporation, a US-based firm, approached them for advice regarding a future transaction scheduled for December 2022, involving an invoice of AUD $10 million. The US firm is uncertain about its exposure to foreign currency fluctuations in December. In response, Wellvet Partners is recommending the use of a forward contract to mitigate this risk, employing the USD/AUD exchange rate when the December forward rate stands at USD 0.760 per AUD, while the spot rate is USD 0.71 per AUD. The size of one USD/AUD forward contract equals AUD 100,000.

Q. Determine the payoff and effective exchange rate for the long or short party if, at expiration, S_Tturns out to be USD 0.780/AUD for AUD$10m

(5 marks)

Q. Find the optimal number of contracts by using the optimal hedge ratio if the historical data estimate R²_{F(Dec USD/AUD)} 0.177, R²_{S (Dec USD/AUD)}0.162, and 0.928

(5 marks)

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