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 producer in Australia will only ship goods in three months’ time due to seasonal differences but payment will have to be conducted six months from now.

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 Canada. The payment of CAD 2,500,000 for the export to Canada 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)
$/CAD	0.76465	0.76559	0.77475	0.76748	0.76843
$/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%
Canada	2.177%	2.069%	2.198%	2.090%	2.220%	2.112%	2.241%	2.133%
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 5 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 $
$/CAD	$0.76292	$0.00392	$0.76828	$0.00392	$0.77205	$0.00387	$0.77747	$0.00387
$/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.)

Canada exchange rate hedges compared:

	Forward rate	Money market hedge locked in exchange rate
$/CAD

Which hedging technique should be applied? ____________________________________

Value of the forward position

Show answer in this row: ($ loss or gain for long/short position in forward)
Show your workings in the columns below the answers

Answer 1

Canada exchange rate hedges compared:

	Forward rate	Money market hedge locked in exchange rate
$/CAD	90 days forward rate = 0.76748	0.766833 (Please see the calculation below)

Borrow CAD 2,500,000 / (1 + i_{CAD, 9 months} x 9 / 12) = 2,500,000 / (1 + 2.220% x 9 / 12) = CAD  2,459,056.71

Convert it into US $ today = CAD  2,459,056.71 x spot rate ($ / CAD) =  2,459,056.71 x 0.76465 = $  1,880,317.71

Maturity amount after 9 months = $ 1,880,317.71 x (1 + i_{US, 9 months} x 9 / 120) = $ 1,880,317.71 x (1 + 2.607% x 9 / 120 = $ 1,917,082.62

Effective exchange rate locked =  $ 1,917,082.62 / CAD 2,500,000 = $ / CAD  0.766833

Hedging technique to be applied: Short forward contract in CAD

Value of the forward position

Show answer in this row: ($ loss or gain for long/short position in forward)	(0.76748 - 0.766833) x 2,500,000 =  $ 1,617.38 (gain)
Show your workings in the columns below the answers