AUS Crystals is a major importer of crystal from Prague in the Czech Republic. The crystal is sold to prestigious retail stores throughout Australia. The imports are denominated in euros (E). Every quarter, AUS Crystals needs E500 million. It is currently attempting to determine whether it should use currency futures or currency options to hedge imports three months from now, if it will hedge at all. The spot rate of the euro is A$1.60. A three-month futures contract on the euro is available for A$1.59 per unit. A call option on the euro is available with a three-month expiration date and an exercise price of A$1.60. The premium to be paid on the call option is A$0.01 per unit. AUS Crystals is confident that the value of the euro will rise to at least A$1.62 in three months. Its previous forecasts of the euro’s value have been very accurate. The management style of AUS Crystals is extremely risk averse. Managers receive a bonus at the end of the year if they satisfy minimum performance standards. The bonus is fixed, regardless of how high above the minimum level one’s performance is. If performance is below the minimum, then there is no bonus and future advancement within the company is unlikely.
A. As a financial manager of AUS Crystals, you have been assigned the task of choosing among three possible strategies: (1) hedge the euro’s position by purchasing futures, (2) hedge the euro’s position by purchasing call options, or (3) do not hedge. Offer your recommendation and justify it.
B. Assume the previous information provided, except for this difference: AUS Crystals has revised its forecast of the euro to be worth A$1.57 in three months from now. Given this revision, recommend whether AUS Crystals should (1) hedge the euro’s position by purchasing futures, (2) hedge the euro’s position by purchasing call options, or (3) not hedge. Justify your recommendation. Is your recommendation consistent with maximising shareholder wealth?