You are the treasurer of Arizona Corp. and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is: Future Spot Rate Probability
$.46 20%
$.48 30%
$.52 50%
The 90-day forward rate of the Australian dollar is $.50.
U. S. deposit rate for 1 year = 1%
U. S. borrowing rate for 1 year = 4%
Australian deposit rate for 1 year = 3%
Australian borrowing rate for 1 year = 6%
(a) What option strategy can Arizona use to hedge its receivables?
(b) What is the probability that the option will be exercised (assuming Arizona purchased it)?
(c) What will be the net receivables if the option is exercised?
(d) Is the option strategy better than a forward contract?
(e) Explain how Arizona can conduct a money market hedge?
(f) What will be the net receivables for Arizona with the money market hedge?
(g) Would leaving the receivables unhedged be better than any of the hedging strategies?