Question

Blue Creek Industrial of Atlanta purchased automated machinery from Sydney Manufacturing of Australia for : A$5,000,000 with payment due in 6 months. The forecasting department of the firm expects the spot rate in 6 months to be $0.7015/A$ The following quotes are available:

Six month investment rate on US$ - 1.20% per annum

Loan Rate on US$ - 4.10% per annum

Six month investment rate on A$2.25% per annum

Loan Rate on A$ - 5.00% per annum

Spot exchange rate :       Bid- $0.7050/A$                Ask- $0.7058/A$

Six month forward rate: Bid- $0.7004/A$                Ask- $0.7018/A$

Six month call option at A$5,000,000 at an exercise price of $0.7100/A$ and a 1.80% of spot ask premium.

Blue Creek’s cost of capital is 10% and it wishes to minimize the dollar cost of this PAYABLE. The CFO has informed your department that the company is currently in a low cash position and if a money market hedge is used, a US dollar loan would be necessary. However, the option premium should be carried forward at the cost of capital.

1. Suppose that Blue Creek from this hedging problem decided to cover only 50% of the A$5,000,000 accounts payable with a forward market hedge and decided to leave 50% uncovered. This is a 50/50 partial forward cover. What would their dollar cost be if the ending spot rate turned out to be $0.7300/A$ and the forward rate was $0.7018/A$? Would this be more or less than the maximum cost of the option hedge? Please show all work

Answer 1