Question

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The budget rate is B= 1.4493 AUD / Euro. The budget rate is a benchmark for...

The budget rate is B= 1.4493 AUD / Euro. The budget rate is a benchmark for the company. An exchange rate below B is acceptable whereas an exchange rate above B will erode the margins of the company and force them to renegotiate contracts with suppliers.

The four (4) month FEC (Foreign Exchange Forward contract) is AUD/EUR 0.6910 (spot of 0.6980 less 70 forward points). (you need to reverse the rate to AUD per 1EUR)

  1. Assume that the company has a payable of Euro 15 million in 4 months. If they hedge that position with the above forward contract, what is the cost of the payable in AUD (after hedging).(5) Is this an acceptable deal when compared to the budget rate? (5)

Solutions

Expert Solution

Given that the budget rate 1.4493 Australian dollar for 1 euro

Here the firm has payable of 15 million euros

Given that the forward contract is euro for Australian dollar that is 0.6910

Hence we will find out Australian dollar for euro = 1/0.6910 = 1.447178

Here the fim has Euro payable that means the firm is afraid of foreign currency ie euro appreciation against Australian dollar.

Here the budgeted rate is 1.4493 Australian dollar for euro and the forward rate is 1.447178 Australian dollar for 1 euro that means we can see that the we can buy euro at a price lower than the budgeted.

Since the exchange rate is below B the company can generate margin more than the planned one

Now the cost of payable due to forward contract will be

15,000,000 * 1.447178 = AUD 2,17,07,670

IF we did not take forward contract we have to pay 15,000,000 * 1.4493 = 21739500

hence the benefit due to forward contract is 21739500 - 2,17,07,670 =31830 AUD.

Hence we can say that this is an acceptable deal.


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