Question Description

Bank applies 360 day-count convention to all currencies. (Students also have to apply 360 days in all calculations). Option premium calculations should include time value calculations based on US $ annual borrowing interest rates for applicable time periods e.g. 3 month $ option premium is subject to 2.687%/4 interest rate.)

a. Calculate the cost of money market hedges for the import from Australia (Complete Table 3 on the separate answer sheet).

b. Determine the option types that you will consider based on the exchange rate quotes provided by your bank. Remember we will long or short the base currencies (in this case study the currencies that are not $) and the FV of premium cost is based on the borrowing cost of $ for the time period of the option. For example if it is a 3 month option, then the interest rate that should be applied is United States 3 month borrowing rate of 2.687%/4 = 0.67175%). Calculate the total cost of using options as hedging instrument for the imports from Australia (Complete Table 4 on the separate answer sheet).

c. Compare the forward quotes, money market hedges and options with each other to determine the best exchange rate hedges for Australia (Complete Table 5 on the separate answer sheet).

d. Calculate the exchange rates that will apply if the money market hedges are used for the exports to Britain (Complete Table 6 on the separate answer sheet).

e. Compare the forward quotes and money market hedges with each other to determine the best exchange rate hedges for Britain (Complete Table 7 on the separate answer sheet).

f. Assume you entered into the forward hedge for the import from Australia. Two months have passed since you entered into the hedge. Interest rates are the same as before. The spot exchange rate of the $/AUD is 0.73000. Calculate the value of your forward position. Please use a 360 day-count convention, since the bank also used a 360 day-count convention with the forward quotes provided to you. Also remember for interest rates use risk free ratesprovided under scenario 1. Show your calculation in table 8 on the separate answer sheet.

Table 1: Calculation of 3 month forward rates using the simple interest rate parity principle (4 marks)

Exchange rate	Forward rate 3 months from now (provide answer with 5th decimal rounding in this column)	Workings (Use of 6th decimal rounding in workings)
/$
AUD$/$

Table 2: Discounts/Premium of US$ (6 marks)

Table 3: Australia import cost with money market hedge: (8 marks)

Exchange rate	% Discount/Premium (Show calculations with answer). Answer must be rounded to 2 decimals. (1 mark each)	State whether positive or negative for imports (1 mark each)	State whether positive or negative for exports (1 mark each)
/$
AUD$/$

PV of foreign currency to be invested

Converted at spot to $ and to be borrowed

$ amount to be repaid after period

Exchange rate locked in with transaction

Show answers in this row:

Show your workings in the columns below the answers (Use 7^thdecimal rounding in workings)

Table 4: Australia import cost with option hedge: (8 marks)

	Type of option (Call or put?)	Total premium cost for import	Total cost of option in $ (Strike plus premium)	Option hedge breakeven exchange rate
Show answers in this row:
Show your workings in the columns below the answers (use 7thdecimal rounding in workings)				Total cost of option in $/ Total AUD value of transaction

Table 5: Australia: Exchange rate hedges compared: (3 marks) Which hedging technique should be applied? (3 marks) ____________________________________ Table 6: Britain export with money market hedge: (8 marks)

	Forward rate	Money market hedge locked in exchange rate	Option hedge breakeven exchange rate
$/AUD

PV of foreign currency to be borrowed

Converted at spot to $ for investment

$ amount with interest invested

Exchange rate locked in with transaction

Show answers in this row:

Show your workings in the columns below the answers (use 7^thdecimal rounding in workings)

Table 7: Britain exchange rate hedges compared: (2 marks)

	Forward rate	Money market hedge locked in exchange rate
$/

Which hedging technique should be applied? (3 marks) ____________________________________ Table 8: Value of the forward position (5 marks)

Show answer in this row: ($ loss or gain for long/short position in forward)

Show your workings in the columns below the answers (use 7^th decimal rounding in workings)