Question 4 (18 Marks)

Duzley Inc., an Australian company, has concluded a large sale of computer systems for inventory management to a customer in France for 3,000,000 with payment due to be received in ninety days. Because this is a sizable contract for the firm, and because the contract is denominated in Euros rather than Australian dollars, Duzley is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information:

DATA VALUES

Account receivable due in 90 days, in 3,000,000

Spot rate (A$/) 1 = A$1.56

90-day forward quote 1 = A$1.5545

Expected spot rate in 90 days 1 = A$1.5782 A$

investment rate 4.00% p.a. investment rate 6.00% p.a.

A$ borrowing rate 6.00% p.a. borrowing rate 12.00% p.a.

Call option strike price (ATM), 90 days, on 1 = A$1.56

Total call option premium (2%) A$93,600

Put option strike price (ATM), 90 days, on 1 = A$1.56

Total put option premium (2.5%) A$117,000

Cost of capital 10.00% p.a.

Required:

a) Does the market prediction (i.e. expectation) imply an appreciation or depreciation in the Australian dollar in relation to the Euro? Please explain why. (2 marks)

b) What would be the outcome if Duzley does not hedge this transaction and the predicted (i.e. expected) exchange rate for 3 months proves to be correct? (2 marks)

c) If Duzley hedges the transaction in the forward market, what should it do? What would be the proceeds of the transaction in 90 days' time? (3 marks)

d) If Duzley locks in a forward hedge and the actual spot rate in 90 days' time turns out to be the expected spot rate, would this result in a 'foreign exchange gain or loss'? What will be the amount of the gain or loss? (3 marks) Formal Exams SP51, 2020 BX3031 Multinational Business Finance Page 6 of 6

e) If Duzley chooses to hedge its transaction exposure in the option market, what action will it take? (2 marks)

f) If Duzley decides to hedge its position using the option suggested in part e), and the actual spot rate in 90 days' time turns out to be the expected spot rate, should Duzley exercise the option? What will be the amount of the gross profit and net profit? (3 marks)

g) If Duzley decides to hedge its position using the option suggested in part e), and the actual spot rate in 90 days' time turns out to be A$1.53/, should Duzley exercise the option? What will be the amount of the gross profit and net profit?