Exchange risk Case Study Example | Topics and Well Written Essays - 1000 words

Exchange risk - Case Study Example They can gain from a one month forward contract and essentially make a profit of (16.136-16.103) = 0.033million AUD. The 0.9450 put option is at a strike price that is not close to making a profit. It is obviously higher than the 1 month forward rate provided. The Australian firm is only worried that the Australian dollar can depreciate against the US dollar on the day of transaction. If 0.9250 is selected, then a higher premium will be payable to the clearing house. The clearing house protects the counterparties against the potential loss in value of the currencies used. Assuming the firm takes the strike at 0.9250, then the premium (insurance) for every option will be (0.0780*15million) = 1.17 million USD, so in 31st October the firm gets (15/0.9250)=16.22 million AUD. The Australian firm buys the put option at the 3 month forward. 15 million USD is equal to 15/0.9257 = 16.203million USD. The premium of the put option is 15million*0.114 = 1.71million USD. If the exchange goes above the strike price then the firm exercises the option and makes profit of (0.2486-0.114)*15=1.98 mill USD. (c) The effectiveness of hedging is that it maintains the value of the $15 million invoice despite any fluctuation in the exchange rate between the two countries. If the invoice payment not hedged, then the 15 million USD can be changed using 31st October spot rate. In case the Australian dollar depreciates against the US dollar, then the firm makes a loss i.e. (16.22-16.13) =0.09mil AUD. The 0.925 option gives us 16.22mil AUD and the one month forward mid-rate of 0.9206 gives us 16.13mil AUD. Which is lower than the former (HICKS 2000). (e) One major amendment made to OTC derivatives trading is; every standardized OTC derivative agreements should be traded on an electronic trading platform or over an exchange. Moreover, OTC derivatives should be cleared through a clearing house by the beginning of January 2013. Contracts that are cleared through a clearing