Calculate the profit that would be made if the exchange rate remains at its current level in three months’ time. How would the profit figure change if the Australian dollar continues to strengthen at the same rate as it has done over the previous year?

Question 1

A trader, who is considering uncovered interest arbitrage between the US dollar (USD) and Australian dollar (AUD), faces the following data:

-Funds available: 2 million USD
-Spot exchange rate: 0.94 AUD per USD
-Spot exchange rate one year ago: 1.00 AUD per USD
-USD 3-month interest rate: 0.12% per annum
-AUD 3-month interest rate: 4.69% per annum

Required

(1) Calculate the profit that would be made if the exchange rate remains at its current level in three months’ time;

(2) How would the profit figure change if the Australian dollar continues to strengthen at the same rate as it has done over the previous year?

Question 2

You are the financial manager of Ashdown plc: a US company which has just signed a contract for the sale of a computer system in the UK for £3,000,000 in a year’s time. You have collected the following data relevant to this project

-Spot exchange rate: $1.2 = £1
-One year forward exchange rate $1.4 = £1
-UK one year interest rate 8%
-US one year interest rate 10%
-Price of a put option for £3,000,000 at an exercise price of $1.3 per pound: £400,000

Required:

(1) How should Ashdown manage the risk arising out of this contract? Discuss and evaluate at least three choices. What is your recommended strategy? Give reasons for your answer. Your answer needs to include all calculations.

(2) In what ways does the exposure faced by Ashdown here differ from other kinds of exposure and what is the impact of this difference on the risk management strategy you have recommended?