Question

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 wine in Australia can be shipped to the United States immediately but you have three months to conduct payment.

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 Britain. The payment of £2,500,000 for the export to Britain 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 days)	6 month (180 days)	9 month (270 days)	12 month (360 days)
$/£	1.30009	1.30611	1.31217	1.31825	1.32436
$/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%
Britain	0.786%	0.747%	0.794%	0.755%	0.801%	0.762%	0.809%	0.770%
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 7 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.

Option prices:

Currencies	3 month options				6 month options
	Call option		Put option		Call option		Put option
	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $
$/£	$1.29961	$0.00383	$1.31268	$0.00383	$1.30564	$0.00381	$1.31876	$0.00381
$/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.)

1. Assume you entered into the forward hedge for the import from Australia. Two months have passed since you entered into the hedge. Interest rates are the same as before. The spot exchange rate of the $/AUD is 0.73000. Calculate the value of your forward position. Please use a 360 day-count convention, since the bank also used a 360 day-count convention with the forward quotes provided to you. Also remember for interest rates use risk free rates provided under scenario 1. Show your calculation in table 8 on the separate answer sheet.

Answer 1

Interest rate of USD for 1month = 2.687%/12 = 0.2239167% (Assume this is risk free rate, since scenario 1 rate not provided)

Interest rate of AUD for 1month = 1.973%/12 = 0.1644167% (Assume this is risk free rate, since scenario 1 rate not provided)

Calculation of value of forward position after 2 months from forward hedge = Spot rate after 2months * (1+Interest rate of USD)/(1+Interest rate of AUD)

= $0.73*(1+0.002239167)/(1+0.001644167)

= $0.73*1.002239167/1.001644167

= $0.7304336/AUD

Forward position = AUD$ 2,500,000*$0.7304336 = $1,826,084