International FInance

INTERNATIONAL FINANCE CASE STUDY EXCHANGE RATE HEDGING QUESTIONS (50 Marks)
INSTRUCTIONS: READ THE QUESTIONS CAREFULLY. ANSWER THE QUESTIONS ON THE SEPARATE
ANSWER SHEET THAT CAN BE DOWNLOADED
You are the manager of a U.S. company situated in Los Angeles and manages the import/export
division of the company. The company distributes (resells) a variety of consumer products imported
to the U.S.A from Australia and also exports goods manufactured in the U.S.A. to Canada.
Therefore, your company is very much dependent on the impact of current and future exchange
rates on the performance of the company.
Scenario 1:
You have to estimate the expected exchange rates one year from now between your home currency
and the other currencies of the major other countries that you deal with in terms of both imports
and exports. The reason is that increases in the values of other currencies compared to the U.S.
Dollar may impact your imports negatively, whilst it may on the other hand, be good for exports. To
do this estimate, you obtain the following spot exchange rate information:
CAD$/$ 1.30779
AUD$/$ 1.38140
You also obtain the following rates that you regard as similar to the annual risk free rates applying in
the countries:
U.S.A. 2.660%
Canada 2.155%
Australia 1.953%
Your focus is presently to estimate the 12 month forward rates in order to consider the impact that
it will have on the import and export sales of the company. Calculate the forward rates of the $ in
terms of all the currencies by using simple interest rate parity e.g. 10% annual interest rate = 10/2 =
5% for six months. Do not effective annual interest rate compounding. Show all your workings in
table 1 on the separate answer sheet by using the correct formula provided in your formula sheet.
Provide an indication about what will happen to the value of the US$ based on the forward exchange
rate calculations by calculating the expected discount/premium of it for each of the currencies in
Table 2 on the separate answer sheet. Also show whether the impact will be positive (P) or negative
(N) for imports and exports. For example:
Exchange % Discount/Premium Import Export

rate
£/$ Workings by you ……………. Positive Negative
= 1.93% premium
Page 1 of 3
Scenario 2:
Considering the calculations you have done so far, you need to attend to a number of import and
export transactions for goods that companies in the United States expressed interest in.
The first transaction is for the import of good quality wines from Australia, since a retail liquor
trading chain customer in the United States, for who you have been doing imports over the past five
years has a very large order this time. The producer in Australia informed you that the current cost
of the wine that you want to import is AUD$2,500,000. The producer in Australia will only ship goods
in three months’ time due to seasonal differences but payment will have to be conducted six months
from now.
The second transaction is for the export of 3d printers manufactured in the U.S.A. The country
where it will be exported to is Canada. The payment of CAD 2,500,000 for the export to Canada will
be received nine months from now.
You consider different transaction hedges, namely forwards, options and money market hedges.
You are provided with the following quotes from your bank, which is an international bank with
branches in all the countries:
Forward rates:
Currencies Spot 3 month (90 6 month (180 9 month (270 12 month (360
days) days) days) days)
$/CAD 0.76465 0.76559 0.77475 0.76748 0.76843
$/AUD 0.72390 0.72516 0.72641 0.72766 0.72892
Bank applies 360 day-count convention to all currencies (for this assignment apply 360 days in all
calculations).
Annual borrowing and investment rates for your company:
Country 3 month rates 6 months rates 9 month rates 12 month rates

Borrow Invest Borrow Invest Borrow Invest Borrow Invest
United
States 2.687% 2.554% 2.713% 2.580% 2.740% 2.607% 2.766% 2.633%
Canada 2.177% 2.069% 2.198% 2.090% 2.220% 2.112% 2.241% 2.133%
Australia 1.973% 1.875% 1.992% 1.894% 2.012% 1.914% 2.031% 1.933%
Bank applies 360 day-count convention to all currencies. Explanation – e.g. 3 month borrowing rate
on $ = 2.687%. This is the annual borrowing rate for 3 months. If you only borrow for 3 months the
interest rate is actually 2.687%/4 = 0.67175% (always round to 5 decimals when you do calculations).
Furthermore, note that these are the rates at which your company borrows and invests. The rates
are not borrowing and investment rates from a bank perspective.
Page 2 of 3
Option prices:
Currencies 3 month options 6 month options

Call option Put option Call option Put option
Strike Premiu Strike Premiu Strike Premium Strike Premium
m in $ m in $ in $ in $
$/CAD $0.76292 $0.00392 $0.76828 $0.00392 $0.77205 $0.00387 $0.77747 $0.00387
$/AUD $0.72155 $0.00690 $0.72843 $0.00690 $0.72279 $0.00688 $0.72969 $0.00688
Bank applies 360 day-count convention to all currencies. (Students also have to apply 360 days in all
calculations). Option premium calculations should include time value calculations based on US $
annual borrowing interest rates for applicable time periods e.g. 3 month $ option premium is subject
to 2.687%/4 interest rate.)
a. Calculate the cost of money market hedges for the imports from Australia (Complete Table 3 on
the separate answer sheet)
b. Determine the option types that you will consider based on the exchange rate quotes provided by
your bank. Remember we will long or short the base currencies (in this case study the currencies
that are not $) and the FV of premium cost is based on the borrowing cost of $ for the time period of
the option. For example if it is a 3 month option, then the interest rate that should be applied is
United States 3 month borrowing rate of 2.687%/4 = 0.67175%). Calculate the total cost of using
options as hedging instrument for the import from Australia (Complete Table 4 on the separate
answer sheet)
c. Compare the forward quotes, money market hedges and options with each other to determine
the best exchange rate hedges for Australia (Complete Table 5 on the separate answer sheet)
d. Calculate the exchange rates that will apply if the money market hedges are used for the exports
to Canada (Complete Table 6 on the separate answer sheet)
e. Compare the forward quotes and money market hedges with each other to determine the best
exchange rate hedges for Canada (Complete Table 7 on the separate answer sheet)
END OF QUESTIONS
Page 3 of 3

International FInance

Uploaded by

Copyright:

Available Formats

International FInance

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

International FInance

Uploaded by

Copyright:

Available Formats

INTERNATIONAL FINANCE CASE STUDY EXCHANGE RATE HEDGING QUESTIONS (50 Marks)

Exchange % Discount/Premium Import Export

Annual borrowing and investment rates for your company:

Country 3 month rates 6 months rates 9 month rates 12 month rates

Currencies 3 month options 6 month options

You might also like