Define transaction-translation and economic exposure

Reference no: EM13203995

Question

a What are the differences between transaction, translation and economic exposure? How can a firm manage these different types of exchange rate risk? Use examples to illustrate your understanding.

b ABC Ltd is an Australian exporter who needs to pay US$100 000 to a shipping company in three months from now for a shipment to the USA. The company is considering hedging currency risk by using a forward and an option. Relevant information is provided below:

i The spot exchange rate is AS/US$ 1.04. However, the company expects in three months the exchange rate will move to AS/US$ 0.80 when it needs to convert Australian dollars to US dollars.

ii The 90 day forward rate of US$ as of today is 1.00.

iii A call option on US$ that expires in 90 days has an exercise price of AS/US$ 1.02 and a premium of A$ 0.01.

Which is the best strategy for ABC to avoid paying the least amount of Australian dollars by hedging its exchange rate risk, forward or option?

Reference no: EM13203995

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