Q2 (26%) You operate a US firm selling your products in Australia. Your firm will be receiving A$1 million from an Australian customer in three months. You would like to hedge against the depreciation of A$ by setting up a currency collar (i.e., combination of one call option and one put option). In order to maintain a sufficient level of working capital, you would like to make sure you will at least be receiving US$690,000 net of any upfront hedging cost. At the same time, you would also like to benefit as A$ appreciates in receiving as much US$ cash flow as possible. You observe the following quotations of currency options on A$. They are European options expiring in three months. Call option on A$ Call option on A$ Put option on A$ Put option on A$ Strike rate US$0.75/A$ US$0.74/A$ US$0.73/A$ US$0.72/A$ Premium (US cents per A$) Bid Ask 1.00 1.05 1.25 1.30 4.65 4.70 4.35 4.40 Given the above currency options, how will you set up a currency collar to satisfy your objectives? What are the maximum and minimum hedged cash flows (in US$) by using the currency collar? Hint: Construct your currency collar by buying a put and selling a call. With the two call options and two put options, there is more than one currency collar you can construct. Select the one that is most optimal in satisfying your objectives. You will find it easier to illustrate by using graphs. Q2 (26%) You operate a US firm selling your products in Australia. Your firm will be receiving A$1 million from an Australian customer in three months. You would like to hedge against the depreciation of A$ by setting up a currency collar (i.e., combination of one call option and one put option). In order to maintain a sufficient level of working capital, you would like to make sure you will at least be receiving US$690,000 net of any upfront hedging cost. At the same time, you would also like to benefit as A$ appreciates in receiving as much US$ cash flow as possible. You observe the following quotations of currency options on A$. They are European options expiring in three months. Call option on A$ Call option on A$ Put option on A$ Put option on A$ Strike rate US$0.75/A$ US$0.74/A$ US$0.73/A$ US$0.72/A$ Premium (US cents per A$) Bid Ask 1.00 1.05 1.25 1.30 4.65 4.70 4.35 4.40 Given the above currency options, how will you set up a currency collar to satisfy your objectives? What are the maximum and minimum hedged cash flows (in US$) by using the currency collar? Hint: Construct your currency collar by buying a put and selling a call. With the two call options and two put options, there is more than one currency collar you can construct. Select the one that is most optimal in satisfying your objectives. You will find it easier to illustrate by using graphs
