Z Gmbh (a German based company) trading in Euros () wants to use money market hedging to reduce currency risk for anticipated future cashflows in Australian Dollars (A$).

The cashflows are as follows:

• A receipt of A$2m after 2 months
• A payment of A$3.5m after 4 months

The current spot rates are A$1.7512 - 1.7578/.

The interest rates available to Z Gmbh are as below:

Deposit (pa) Borrowing (pa)

Germany 3.75% 9.15%

Australia 2.65% 8.35%

1. Perform a money market hedge on each of the two transactions individually.

2. Combine the transactions (i.e. attempt to net off the payment with the receipt) and perform a money market hedge on the balance.

3. Critically assess the useful and prevalence of money market hedging as a method of managing foreign currency risk .

4. If inflation in Australia was 4% per annum and 7% in Germany use the Fischer equation to calculate what the spot rates would have been on the transaction date and whether, with the benefit of hindsight, they should have used a money market hedge.

Further financial information was gathered regarding alternative forms of hedging as below:

F_2mth 0.0731 0.0085c/ premium

F_4mth 0.1417 0.1058c/ premium

	Call options (c/)		Put options (c/)
	2 months	4 months	2 months	4 months
K = $1.7450/	0.87	0.98	0.41	0.55

The future spot rates are anticipated to be as below:

S_2mth A$1.7490 - 1.7538/

S_4mth A$1.7432 - 1.7482/

5. What would be the proceed from the receipt and the cost for the payment if the above Forward rates were used separately on the transactions?

6. What would be the proceed from the receipt and the cost for the payment if the above options were used separately on the transactions?

7. Discuss the principle of purchasing power parity and evaluate its ability to act as a standard of currency valuation. (Max word count is 50 words)

8. Compare and contrast the motivation, risk appetite and objectives of speculators and hedgers. (Max word count is 90 words)