Suppose you are the assistant treasurer of a tractor manufacturing company in United States. Today is 10 July 2020 and your firm is going to receive a payment of AUD1,638,000 from your Australian customer in exactly three months time for the tractors your firm sold to him.

The treasurer of your company, Zoe Lee, who is also your boss, is concerned that the Australian dollar exchange rate might fall between now and October and would like to lock in the value of this future income today. This morning you have asked OUHK Bank to provide following currency data to you:

10 July 2020 Currency Forwards

Currency Spot

EUR/USD 1.3043 AUD/USD 0.9066 GBP/USD 1.5109

1-month

1.3045 0.9046 1.5106

3-month

1.3048 0.9008 1.5100

6-month

1.3055 0.8954 1.5092

1. a Demonstrate how you would use a currency forwards contract to hedge the risk exposure. Calculate the value, in term of USD, which your firm would effectively lock in based on the above currency quotations. (7 marks)

2. b Suppose that three months later the spot rate becomes AUD/USD0.9108. Work out the profit or loss on your forward contract position. (4 marks)

3. c Compare the original exchange rate of AUD/USD0.9066 with the three-month-later spot rate of AUD/USD0.9108 and analyse any gain or loss of funds in terms of US dollars. (4 marks)

4. d With the results in parts (a) to (c), explain how the forward contract has eliminated the firms exposure to the fluctuation in the Australian dollar exchange rate. (10 marks)

5. e Explore any alternatives other than currency forwards. Discuss your recommendations. (15 marks)