Question

. As a US exporter, we have the option of hedging with forwards, options, or not hedging. The size of the transaction is 3.04 million Australian $. The current Exchange Rate is .7400-05 AUDUSD, and the 3 month forward Rate is .7500-05 AUDUSD. Australian Dollar options with an exercise price of .75 sells for a price of $.05 for calls and $.04 for puts. There are 100,000 Australian dollars in 1 option contract.

In 3 months when the transaction occurs, the final exchange rate is .700-02 AUDUSD, and option prices are .00 for calls and .10 for puts. (10)

a) How much would you receive/pay if you had hedged with forwards?

b) How much would you receive/pay if you had hedged with options?

c) How much would you receive/pay if you had not hedged?

d) Rank them

Answer 1

Answer - a

Amount received by the US exporter under hedging with forwards

Amount received = Transaction amount * Exchange rate

Where -

Transaction amount = 3,040,000 AUD

Exchange rate is the 3 month forward rate given as 1 AUD = 0.7500 USD i.e. the buying rate of the exchange dealer.

Hence, on putting the calculated figures in the above formula, we get -

Amount received = Transaction amount * Exchange rate

Amount received = 3,040,000 AUD * 0.7500 USD

Amount received = 2,280,000 USD

Answer - b

Amount received by the US exporter under hedging with options

Amount received = (Contract amount * Exercise price) + (Uncontracted amount * 3 month spot rate) - Option premium

Where -

1. Exercise price of Australian dollar options given as 1 AUD = 0.75 USD

2. Option premium can be calculated as below-

Option premium = Number of contracts * Lot size * Price for put option

Where, Number of contracts = Transaction amount / Lot size per contract

Number of contracts = 3,040,000 AUD / 100,000 AUD

Number of contracts = 30.40 $\simeq$ 30 contracts (a contract cannot be purchased in fractions, hence the remaining uncontracted amount shall be received at 3 month spot rate)

Price for put option = 0.04 USD

Hence,

Option premium = Number of contracts * Lot size * Price for put option

Option premium = 30 * 100,000 AUD * 0.04 USD

Option premium = 120,000 USD

3. Contract amount = Number of contracts * Lot size

Contract amount = 30 * 100,000 AUD

Contract amount = 3,000,000 AUD

4. Uncontracted amount = Transaction amount - Contract amount

Uncontracted amount = 3,040,000 AUD - 3,000,000 AUD

Uncontracted amount = 40,000 AUD

5. 3 month spot rate is given as 1 AUD = 0.700 USD i.e. the buying rate of the exchange dealer.

Hence, on putting the calculated figures in the above formula, we get -

Amount received = (Contract amount * Exercise price) + (Uncontracted amount * 3 month spot rate) - Option premium

Amount received = (3,000,000 AUD * 0.75 USD) + (40,000 AUD * 0.70 USD) - 120,000 USD

Amount received = 2,250,000 USD + 28,000 USD - 120,000 USD

Amount received = 2,158,000 USD

Answer - c

Amount received by the US exporter if no hedging is done

Amount received = Transaction amount * Exchange rate

Where -

Transaction amount = 3,040,000 AUD

Exchange rate is the 3 month spot rate given as 1 AUD = 0.700 USD i.e. the buying rate of the exchange dealer.

Hence, on putting the calculated figures in the above formula, we get -

Amount received = Transaction amount * Exchange rate

Amount received = 3,040,000 AUD * 0.700 USD

Amount received = 2,128,000 USD

Answer - d

Statement showing ranking of amount received by the US exporter

Particulars	Amount received (USD)	Rank
Forward Hedge	2,280,000	I
Option Hedge	2,158,000	II
No Hedge	2,128,000	III