Part (a)

A speculator writes (or sells) a call option on the Australian dollar (AUD) at an exercise exchange rate (or strike price) of 0.7200 (USD/AUD). The size of the option contract is AUD 100,000. The premium is USD 0.0040 per AUD. Ignore all interest rates.

(i) At which spot exchange rate on the expiration date will the speculator break even? (ii) Assume that the spot exchange rate on the expiration date is 0.7100 (USD/AUD). Calculate the value of the option and the speculator's net profit/loss.

Part (b)

An American importer is due to pay AUD 1,500,000 in six months to a firm in Australia. The following information is available:

Spot exchange rate (USD/AUD) Six-month forward rate (USD/AUD) Six-month interest rate in the United States Six-month interest rate in Australia

0.7200

0.7250

1% per annum 0.5% per annum

(i) Calculate the USD value of the payables under a forward market hedge.

(ii) Calculate the USD value of the payables under a money market hedge. In doing so, clearly outline the steps required to perform the money market hedge.

(iii) Assuming that uncovered interest parity holds, how much would the importer expect to pay if the position remains unhedged?