Question

Kogan, an Australian online retailer, has an liability of 1,500,000 EUR payable in one year to a bank in Germany. The current spot rate is 2.1205 AUD/EUR and the one year forward rate is 2.1185 AUD/EUR. The annual interest rate is 4% in Germany and 3.5% in Australia. The company can also use options on EUR at the strike price of 2.1200 AUD/EUR for a premium of 0.05 AUD/EUR. Suppose the future exchange rate is 2.1225 AUD/EUR. The AUD outcome of using the money market hedge for this transaction is

Select one:

a.  $3,165,457.93

b. none of the options

c. $3,058,413.46

d.  $3,177,750.00

e.  $3,180,750.00

Answer 1

Money Market hedge
	Liability in EUR	1,500,000
	So the equivalent amount is deposited today in Germany bank so that the amount after
	1 year becomes 1,500,000. The amount required to deposit today will be taken on loan
	in Australia.
	Deposit amount=	1500000/(1+4%)
	Deposit amount=	1,442,307.69
	This gets converted back to AUD at the current spot rate
	Equivalent AUD	1442307.69*2.1205
	Equivelent AUD	3,058,413.46
	The amount payable in Australia after 1 year on this loan	3058413.46*(1+3.5%)
	The amount payable in Australia after 1 year on this loan	3,165,457.93
	So cash outgo after 1 year in AUD will be 3,165,457.93. Hence, option A is the right answer.