Problem
EV Direct Pty Ltd. is a local car importer in Australia. EV Direct just signed a purchase agreement to purchase electric vehicles from a Chinese car manufacturer--BYD. The purchase will be billed CNY 1,000,000, payable in six months. The current spot exchange rate is AUD 0.22/CNY. However, a senior manager in EV Direct worries that the future foreign exchange rate may fluctuate and hurt the amount payable. Therefore, the manager asks you, a financial risk analyst, to provide him with an appropriate hedging technique.
The following is information on the currency derivative market:
1. 6-month CNY forward contract with a strike price of AUD 0.25/CNY
2. 6-month CNY call option with an exercise price of AUD 0.24/CNY (premium is AUD 0.05/CNY)
3. 6-month CNY put option with an exercise price of AUD 0.21/CNY (premium is AUD 0.04/CNY)
4. Interest rate in Australia is 3.5% p.a.
5. Interest rate in China is 4.5% p.a.
A. You conduct due diligence research and believe that AUD will depreciate dramatically in 6 months. If your analysis is correct, will you suggest that your manager hedge against CNY payable? Yes or No and provide one sentence for your rationale.
B. Disregard question (A). If you decide to hedge through an option contract, what is the cost of premium in the dollar today?
C. EV Direct also opens a subsidiary in New Zealand and its main business is to distribute electric cars in New Zealand. However, you remind the manager that EV Direct is still subject to translation exposure. The subsidiary in New Zealand has an asset of NZD 2.5 billion and a liability of NZD 1.5 billion. If the exchange rate were to change from AUD 0.88/NZD to AUD 0.90/NZD, what would be the gain or loss in AUD billion?