Estimate present value of the cost of defaults on contract

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A company enters into a 1-year forward contract to sell $100 for AUD150. The contract is initially at the money. In other words, the forward exchange rate is 1.50. The 1-year dollar risk-free rate of interest is 5% per annum.

The 1-year dollar rate of interest at which the counterparty can borrow is 6% per annum. The exchange rate volatility is 12% per annum.

Estimate the present value of the cost of defaults on the contract. Assume that defaults are recognized only at the end of the life of the contract.

Reference no: EM131239663

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