Foreign Currency

FOREIGN CURRENCY HEDGING

Working:

1. As the bank will deliver USD it will use the ask rate to calculate the premium for delivery on the 5th of August ’07 as follows:

Pro-rata, the premium for 11 days would be = 9 x 11/31 = 3 points. So the total premium would be 24 points and the ask rate would be 1.2218.

If this is the rate obtained from the bank, the amount to be delivered would be

=5,000,000 x 1.2218 = AUD 6,109,000

2. On August 5, USD will have to be purchased from the market. For hedging, the opposite position has to be held, that is, on that day USD will have to be sold or equivalently, AUD will have to be purchased. For this and to have the USD value of the futures position as close to the actual payable, one has to purchase on 25th May:

5,000,000/(0.8230 x 100,000) = 60.75 or 61 AUD futures contracts.

3. On 3rd August, if the futures hedge is lifted, the loss will be

(0. 8145 – 0.8068) x 61 x 100,000 = USD 46,970 = AUD 46,970/0.8183

= AUD 57,399

4. USD that will be delivered by the bank under forward contract = 5,000.000

Balance USD that has to be purchased from the market = 5,000,000

Loss in futures market that would have to be borne in USD = 46,970

Total USD required = 10,046,970

Yen loan required to purchase this at the rate of 120.48= 10,046,970 x 120.48

= 1,210,458,946