Question

The first transaction is for the import of good quality wines from Australia, since a retail liquor trading chain customer in the United States, for who you have been doing imports over the past five years has a very large order this time. The producer in Australia informed you that the current cost of the wine that you want to import is AUD$2,500,000. The wine in Australia can be shipped to the United States immediately but you have three months to conduct payment.

The second transaction is for the export of 3d printers manufactured in the U.S.A. The country where it will be exported to is Britain. The payment of £2,500,000 for the export to Britain will be received nine months from now.

You consider different transaction hedges, namely forwards, options and money market hedges.

You are provided with the following quotes from your bank, which is an international bank with branches in all the countries:

Forward rates:

Currencies	Spot	3 month (90 days)	6 month (180 days)	9 month (270 days)	12 month (360 days)
$/£	1.30009	1.30611	1.31217	1.31825	1.32436
$/AUD	0.72390	0.72516	0.72641	0.72766	0.72892

Bank applies 360 day-count convention to all currencies (for this assignment apply 360 days in all calculations).

Annual borrowing and investment rates for your company:

Country	3 month rates		6 months rates		9 month rates		12 month rates
	Borrow	Invest	Borrow	Invest	Borrow	Invest	Borrow	Invest
United States	2.687%	2.554%	2.713%	2.580%	2.740%	2.607%	2.766%	2.633%
Britain	0.786%	0.747%	0.794%	0.755%	0.801%	0.762%	0.809%	0.770%
Australia	1.973%	1.875%	1.992%	1.894%	2.012%	1.914%	2.031%	1.933%

Bank applies 360 day-count convention to all currencies. Explanation – e.g. 3 month borrowing rate on $ = 2.687%. This is the annual borrowing rate for 3 months. If you only borrow for 3 months the interest rate is actually 2.687%/4 = 0.67175% (always round to 7 decimals when you do calculations). Furthermore, note that these are the rates at which your company borrows and invests. The rates are not borrowing and investment rates from a bank perspective.

Option prices:

Currencies	3 month options				6 month options
	Call option		Put option		Call option		Put option
	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $
$/£	$1.29961	$0.00383	$1.31268	$0.00383	$1.30564	$0.00381	$1.31876	$0.00381
$/AUD	$0.72155	$0.00690	$0.72843	$0.00690	$0.72279	$0.00688	$0.72969	$0.00688

Bank applies 360 day-count convention to all currencies. (Students also have to apply 360 days in all calculations). Option premium calculations should include time value calculations based on US $ annual borrowing interest rates for applicable time periods e.g. 3 month $ option premium is subject to 2.687%/4 interest rate.)

a. Calculate the cost of money market hedges for the import from Australia (Complete Table 3 on the separate answer sheet).

Table 3: Australia import cost with money market hedge:

	PV of foreign currency to be invested	Converted at spot to $ and to be borrowed	$ amount to be repaid after period	Exchange rate locked in with transaction
Show answers in this row:
Show your workings in the columns below the answers (Use 7th decimal rounding in workings)

Answer 1

A)
Australia Transaction- Wine import of AUS$- 2,500,000
Payment Duratio= 3 months
Here the risk of the importer is that if the value of AUS$ becomes stronger he will have greater outflow in USD
To cover the risk following options are available with the importer
Under money market operation the US importer will borrow an amount which he will invest in autralia for 3 months
which equates to AUD$ 2,500,000
Exposure: 2,500,000 Payable:
Deposit rate 3 Months(90 days) in Australia= 1,875% PA
Borrowing rate in USA for 3 months(90 Days)= 2.687% PA
Spot Rate $/AUD= 0.72390
WN-1 Calculation of amount to be invested in australia
	Annual Rate= 1.875%
	Rate per month	1.875%/12 =		0.0015625
	Rate for 3 months	0.001563*3=		0.0046875
	Amount to be invested=	2,500,000/1.004688		2,488,334.69
	B29	C29
	PV of Foreign Currency to be invested	Converted at spot to $ and to be borrowed	Formula used	$ amount to be repaid after period	Formula used	Exchange rate locked in with transaction
WN-1	2,488,334.69	1,801,305.48	B29*0.7239	1,813,405.75	C29+(C29*0.02687/12*3)	0.7239
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