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.
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