Hedge, Speculate, or take an Arbitrage position

Mary Martin, the CEO of Banon Camera Company in Sydney has made a contract on 31/Mar/2021 to deliver US$5,000,000 worth of products to a US company in six months (31/Sep/2021). To make the products, which are mainly high-end DSLR cameras, Banon Co. has ordered AUD$3,000,000 worth of materials such as batteries, lens, CMOS chips to be able to meet the delivery in six months. The payment for the raw materials will be made once the materials are delivered in one month.

To prepare for the payments of AUD$3,000,000 for the materials Mary is considering raising capital through debt with payments due semi-annually. The bond is to last for one year and an independent credit rating company has rated Banon Co. as an AAA company. In the past, Mary paid LIBOR + 2% per annum for the most recently retired debt. The CFO of Banon Co. has indicated the maximum amount that can be raised through debt is AUD$5,000,000. Also, the CFO has been contacted by Codak Co. to discuss a possible swap contract among the two companies where the profits through the swap are to be shared equally.

Once the products are delivered six months later, the payment of US$5,000,000 should be transferred to Banon Co.'s Australian account. This requires an international currency exchange transaction. The board members of Banon Co. do not want to take risk of a sudden change in the US dollar versus the Aus. dollar exchange rate.

Quotes for Exchange rates (31/Mar/2021)		Exchange rate
Spot ($/A$)		0.7600/5
One month forward($/A$)		10/15
Three months forward ($/A$)		32/43
Six months forward ($/A$)		105/145

Company Credit rating and interest payments in the Bond market
Assumptions		Banon		Codak
Credit rating		AAA		BBB
Past preference to borrow		Floating		Fixed
Fixed-rate cost of borrowing (p.a.)		8.000%		12.000%
Floating-rate cost of borrowing: (p.a.)
LIBOR (value is unimportant)		5.000%		5.000%
Spread		1.000%		2.000%
Total floating-rate		6.000%		7.000%

Expected Economic Data from 31/Mar/2021~2022		Interest rate (p.a.)	Inflation rate (p.a.)	Unemployment rate
US		3%	1%	4.5%
Australia		5%	3%	5.2%

Required: Question to Answer

As a consultant you were hired by Mary to provide them with a summary report on exchange rate fluctuations and expectations. For the report you first decide to establish an exchange forecasting model which will be able to predict the six months ahead spot rate. Using the forecast and provided market data, you are tasked to search opportunities to hedge, speculate, or take arbitrage of the current financial market for the next six months. For each opportunity you should provide a justification of why the positions should be taken and how it would benefit Banon Co.. Assume that the date today is 31/Mar/2021.

In your 2,000 word report you are to provide information of the following:

1. Explain the prediction model(s) you have established.

2. Explain how you collected the data for the models and what issues you faced in selecting the data.

3. Provide a prediction for the USD/AUD spot exchange rate for 31/Sep/2021 (six months from now)

4. How should Banon Co. hedge the transaction exposure of US$5,000,000 receivable in six months?

5. Provide one speculative opportunity that Banon Co. can take today with an investing period of six months.

6. What is the cheapest way to raise capital through debt or swaps for Banon Co. to purchase the materials worth AU$3,000,000?

Suggested Report Structure

Your report should be structured in a professional manner, free from grammatical errors and include a References list.

Headings within your report could include:

1. Exchange Rate Prediction
   1. Collection of data
   2. Regression or Model of your choice
   3. Prediction of USD/AUD spot rate

2. Foreign exchange strategies
   1. Hedging the transaction exposure
   2. FX rate speculation profits
   3. Raising Capital