Reference no: EM133495662

Your Australian company has just made a contract to buy heavy machinery from a German company. Your company must pay German company €300,000 in three months. You have three alternatives (any combination allowed) to hedge this FX exposure: (a) buying a call option at a strike price of A$1.45 per euro. The premium for this call option is A$0.02 per euro or (b) buying a three-month euro forward contract from a German Bank, which quotes you A$1.47 per euro or (c) buying a futures contract (assuming no transaction costs and no margin account requirements) at a price of A$1.465 per euro. Using this information,

1. Discuss what kind of exposure your company has. Does it matter to remain unhedged for this exposure? Discuss your arguments.

2. As an expert FX dealer, you expect that the euro in three months (when your payment is due to German company) would be settled at A$1.48 and to your surprise, it happened so, i.e., euro settled at A$1.48 after 3-months. What would be your company's gains or losses if you did allocate €300,000 equally to option contract and futures contract to hedge this FX exposure (show your workings)?

3. What is the call option writer's profit (loss) if the euro in three months is settled at A$1.46 (Must show your workings)? Imagine the option writer issued the contract for the entire FX exposure (i.e., €300,000).