Question

**(a)** You have just arrived back from Canada
after a very successful business trip. You have managed to sell the
designs to a new invention and you will be are paid in 9 months
time. You expect to receive a total of CAD 100,000.

You note that today the spot exchange rate is AUD1.15/CAD and the 9 months forward rate is AUD1.17/CAD. Today, this forward rate is also your expected spot exchange rate in 9 months time. Today, you can also buy a 9 months put option on the CAD with an exercise price of AUD1.1600/CAD for a premium of AUD0.09 per CAD. The 9 month interest rate is 4 % per annum in Australia and 6% per annum in Canada.

**REQUIRED:**

**(i)** Calculate the expected AUD premium of
selling CAD 100,000 if you choose to hedge by a put option on the
CAD. **[2 Marks.]**

*Give your answer to the nearest dollar*.

$Answer

**(ii)** Calculate the future AUD receipt if you
decide to hedge using a forward contract. **[2
Marks.]**

*Give your answer to the nearest dollar*.

$Answer

**(iii)** Based on the concept of Interest Rate
Parity, what should the forward rate be? **[2
Marks.]**

*Give your answer to 4 decimal places.*

Answer AUD/CAD

**(b)** The USD is trading at a spot price of
AUD1.500/AUD. Further, assume that the premium of an American call
option with an exercise price of AUD1.51/USD is 12.50 Australian
cents and of an American put option with an exercise price of
AUD1.5500/USD is 17.10 Australian cents.

**REQUIRED:**

**(i)** Calculate the intrinsic values of the call
and put options. **[1 + 1 = 2 Marks.]**

*Give your answer in cents. For example, 1.23 means 1.23c, or
$0.0123.*

PUT: Answer cents

CALL: Answer cents

(ii) Calculate the time value of the call and put options.
**[1 + 1 = 2 Marks.]**

*Give your answer in cents. For example, 1.23 means 1.23c, or
$0.0123.*

PUT: Answer cents

CALL: Answer cents

Answer #1

a

i) Expected AUD premium of Selling CAD using put options = AUD
0.09 .CAD * 100000 CAD =**AUD 9000**

ii) Using forwards, Future AUD receipt = AUD 1.17/CAD * 100000
CAD = **AUD 117000**

iii) As per Interest rate parity

9 month forward rate = Spot rate * (1+ interest rate in Australia *9/12) /(1+ interest rate in Canada *9/12)

= 1.15*(1+0.04*9/12)/(1+0.06*9/12)

=1.1335

**The forward rate after 9 months should be AU 1.1335/CAD
as per Interest rate parity**

**b) i)**

Intrinsic value of call option = max(Spot price - strike price,
0) = max(1.50-1.51,0) = **0 or 0 Cents**

Intrinsic value of put option = max(strike price- spot price, 0)
= max(1.55-1.50,0) = **AUD 0.05 or 5 cents**

ii)

Time value of call option = Premium - Intrinsic value = 12.50
cents -0 cents = **12.50 Cents**

Time value of put option = Premium - Intrinsic value = 17.10
cents -5 cents = **12.10 Cents**

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