The following is a comprehensive hedging problem. Suppose today is January 2 and BSK, Inc. is a US firm that has the following Canadian dollar (CAD) and Australian dollars (AUD) cash flows due in 6 months (July 2):

Receivables Payables

Canadian dollar CAD2,000,000 CAD1,735,000

AUD AUD 2,765,000 AUD 3,700,000

Suppose also you have the following information regarding foreign exchange rates, interest rates, and futures and options prices, all reported as of January 2:

Bid Ask

Spot: CAD 1.2605/$ CAD 1.2610/$

AUD 1.3610/$ AUD 1.3615/$

6-mo forward CAD 1.2673/$ CAD 1.2682/$

AUD 1.3500/$ AUD 1.3515/$

Annualized interest rates on 6-month deposits and 6-month loans:

Deposit Lending

US 2.35 2.45

Canada 2.80 2.90

Australia 1.50 1.58

Assume Futures Prices on Jan 2 $/CAD $/AUD

Sept. futures (futures matures on September15) $0.7880/CAD $0.7420/AUD

(1 CAD contract = CAD 100,000; 1AUD contract = AUD100,000, both maturing in September, and one cannot go long or short fractions of a contract)

Options market prices on Jan. 2, (Note: Quotes below are in US cents/1FX on Sept. Contracts):

Call Prem Put Prem

Sept option on CAD w/ 80 strike 1.17 1.45

Sept option on AUD w/74 strike 1.14 1.90

(Suppose 1 CAD options contract = CAD50,000; 1AUD options contract = 50,000 AUD, and assume one cannot buy fractions of the options contracts)

Question: Suppose now the firm wishes to hedge its foreign exchange risk using foreign exchange options.

(i) What kind of options should the firm purchase to hedge its risk (i.e. calls or puts)? How many contracts should the firm purchase?

(ii) Assume on January 2 the firm buys options at the prices quoted at the beginning of the problem. Suppose the spot rates on July 2 turn out to be the same as in part (d) above:

Bid Ask

Spot: CAD 1.2682/$ CAD 1.2690/$

AUD 1.3508/$ AUD 1.3523/$

Given these spot rates, on July 2 will the firm exercise the options it had purchased? What will the firm pay or receive (number of $) for CAD and AUD 6 months from Jan.2 (i.e. on July 2) given it hedged its risk in the options market (consider all costs)? can I have your calculation details thanks!