An Australian firm is due to receive EUR 1,500,000 in six months from an European
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An Australian firm is due to receive EUR 1,500,000 in six months from an European

Problem 2

An Australian firm is due to receive EUR 1,500,000 in six months from an European firm. The following information is available:

Spot exchange rate (AUD/EUR)                                         1.3150

Six-month interest rate in Australia                         4.0% per annum

Six-month interest rate in the Euro zone               2.0% per annum

Put option on EUR exercise price (AUD/EUR)                 1.3300

Premium on EUR put option AUD                             0.05 per EUR

Time to expiry on put option                                     Six months

(i) Calculate the AUD value of the receivables under a money market hedge. In doing so, clearly outline the steps required to perform the money market hedge.

(ii) Assume that covered interest parity holds and that the forward exchange rate is the best predictor of the future spot exchange rate in the next six months. Based on this, calculate the expected AUD value of the receivables using the option market hedge.

Hint
Accounts & FinanceMoney market hedge: It is a technique which used to lock in the value of a foreign currency transaction in a domestic currency of the company. Therefore, the money market hedge could help the domestic company reduce its exchange rate or even the currency risk when conducting business transactions with a foreign company....

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