Question

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An Australian exporter WA Co. will receive 5.04 million Chinese yuan (CNY) from a Chinese importer...

An Australian exporter WA Co. will receive 5.04 million Chinese yuan (CNY) from a Chinese importer Sing Tao in one year. WA Co. analyses the different hedging strategies (forward, money market and options) using the market information in the following Table 1 to minimise its exchange rate risk for the Australian dollar (A$) cash flow.

TABLE 1

For Chinese yuan (CNY)

Spot rate

A$0.4100/CNY

One-year forward rate

A$0.5769/CNY

One-year CNY deposit and borrowing rate

7.14%

One-year call options

Exercise price = A$0.61

Premium = A$0.04

One-year put options

Exercise price = A$0.58

Premium = A$0.06

For Australian dollar (A$)

Spot rate

CNY3.5754/A$

One-year forward rate

CNY1.8740/A$

One-year A$ deposit and borrowing rate

4.93%

One-year call options

Exercise price = CNY1.78

Premium = CNY0.19

One-year put options

Exercise price = CNY2.35

Premium = CNY0.12



Calculate the A$ proceeds from the forward hedging strategy based on the information in Table 1. (enter the whole number without sign and symbol).

Calculate the A$ proceeds for the money market hedging strategy using the market information in Table 1. (enter the whole number without sign and symbol)

Calculate the minimum A$ proceeds for the options hedging strategy based on the market information in Table 1. (enter the whole number without sign and symbol)

After analysing the different hedging strategies, WA Co. found that none of these hedging strategies (forward, money market and options) provides the expected A$ proceeds and wants to receive A$ rather than CNY in one year. Therefore, WA Co. proposed Sing Tao to pay WA Co. A$2.71 million instead of the initial an agreed amount of CNY5.04 million. As an importer before signing a new agreement, Sing Tao analyses the different hedging strategies using the market information in Table 1 to minimise its exchange rate risk for the payment of A$2.71 million. What is the CNY costs for the forward hedging strategy based on the information in Table 1? (enter the whole number without sign and symbol)

What is the CNY costs for the money market hedging strategy based on the information in Table 1? (enter the whole number without sign or symbol)

Calculate the maximum CNY costs for the options hedging strategy using the information in Table 1.

Solutions

Expert Solution

Part a) Forward hedging:
CNY 5.04million receivable in one year.
One year forward rate = A$0.5769/CNY
A$ proceeds from the forward hedging strategy = CNY 5,040,000*A$0.5769/CNY = A$2,907,576

Part b) Money market hedging:

Action Computation Amount
Borrow present value of CNY 5.04million @ 7.14% for 1year CNY 5,040,000/1.0714 CNY 4,704,125.44
Convert the borrowed money into A$ by using spot rate CNY 4,704,125.44*A$0.41 A$1,928,691.43
Deposit the A$1,928,691.43 for 1year @ 4.93%
Realise the maturity from deposit after 1year along with interest A$1,928,691.43*1.0493 A$2,023,775.92
Settle the borrowing of CNY4,704,125.44 along with interest by using receivables of 5.04million

A$ proceeds for the money market hedging strategy = A$2,023,775.92

Part c) Option hedging:
The australian exporter WA Co, has receivable of CNY 5.04million after 1 year. So the exporter has to sell CNY 5.04million after 1year, so he will enter into one-year put option with exercise price of A$0.58.
Put option premium payable at present = A$0.06/CNY = CNY5.04million*A$0.06 = A$302,400
Borrow the premium payable @ 4.93% for 1year & pay the put option premium.
Assume the option is exercised, receive A$ of 2,923,200 (CNY5.04million*A$0.58)
Repay the maturity value of borrowing = A$302,400*(1+0.0493) = A$302,400*1.0493 = A$317,308.32
Minimum A$ proceeds for the options hedging strategy = A$2,923,200-A$317,308.32 = A$2,605,891.68

Part d) Forward hedging for A$2.71million:
A$2.71million payable in one year.
One year forward rate = CNY1.8740/A$
CNY cost for the forward hedging strategy = A$ 2,710,000*CNY1.8740/A$ = CNY 5,078,540

Part e) Money market hedging for A$2.71million:

Action Computation Amount
Deposit present value of A$2.71million @ 4.93% for 1year A$ 2,710,000/1.0493 A$ 2,582,674.16
Convert the depositing amount into CNY by using spot rate A$ 2,582,674.16*CNY3.5754 CNY 9,234,093.20
Borrow the CNY9,234,093.20 for 1year @ 7.14%
Realise the maturity from deposit after 1year along with interest & settle the A$2.71 payable
Repay the borrowing of CNY9,234,093.20 along with interest CNY 9,234,093.20*1.0714 CNY 9,893,407.46

CNY cost for the money market hedging strategy = CNY 9,893,407.46

Part f) Option hedging:
The chinese importer Sing Tao, has payable of A$ 2.71million after 1 year. So the importer has to buy A$2.71million after 1year, so he will enter into one-year call option with exercise price of CNY1.78/A$.
Call option premium payable at present = CNY0.19/A$ = CNY0.19*A$2.71million = CNY514,900
Borrow the premium payable @ 7.14% for 1year & pay the call option premium.
Assume the option is exercised, pay CNY of 4,823,800 (A$2.71million*CNY1.78)
Repay the maturity value of borrowing = CNY514,900*(1+0.0714) = CNY514,900*1.0714 = CNY 551,663.86
Maximum CNY cost for the options hedging strategy = CNY4,823,800+CNY 551,663.86 = CNY 5,375,463.86


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