Lunar Capital Partners (LCP) is an Australian Private Equity firm. They invest in assets in both Australia and New Zealand. The fund predominantly raises capital in Australian dollars and its distributions are denominated in Australian dollars. LCP are considering purchasing a New Zealand auto-repair chain, AutoNZ, for a total cost of NZD50m. If the deal took place, it would require LCP to pay this amount in one month from today. The General Partners of LCP are concerned about the currency risk of this potential deal. You work for a major global investment bank on the currency desk. They have asked you to discuss possible hedging alternatives with them. Specifically, they wish to consider the following alternatives: Entering into an FX forward contract. Purchasing an option with strike price equal to 0.9250. They are provided with the following quotations in the FX spot market, FX forward market, Australian and New Zealand Money Markets (1 month interest rates in both countries) and the FX option markets: Table 1: Market Prices FX: Bid Ask 1m Money Markets: Australia 0.9175 0.9185 S(AUD/NZD) F 1m(AUD/NZD) Borrowing Lending 0.675%pa 0.575%pa 1.840%pa 1.740%pa 0.9174 0.9184 New Zealand FX Option: NZD Call / AUD Put 1 month K = 0.9250 Premium (AUD)1 Premium (AUD)1 NZD Put / AUD Call 1 month K = 0.9250 0.0066 0.0134 1FX option premia are quoted in AUD required to purchase the stated option per 1 unit of NZD. QUESTION For the two hedging alternatives LCP are considering, which alternative has the lowest maximum possible downside for LCP if the deal does not complete? Explain your