You are working with a Hong Kong company in Kowloon which has ordered some goods...
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You are working with a Hong Kong company in Kowloon which has ordered some goods from Malaysia worth RM70,000. The payment will be made in three months. You know that the exchange rate between Malaysian ringgit and Hong Kong dollar (HK$) has not been stable recently, so you need to hedge against any change in the HK$/RM. After doing some information search, you gather the followings; the spot exchange rate is HK$0.60/RM, 3-month forward rate is HK$0.63/RM, 3-month call option on RM has an exercise rate of HK$0.64/RM for a premium of HK$0.05 for every RM, the 3-month interest rate is 6 percent in Hong Kong and 4 percent in Malaysia. You expect future spot rate to be the same as the forward rate. (i) Analyze expected Hong Kong dollar cost of buying RM5,000 if you choose to hedge by a call option on RM. [4 marks] (ii) Analyze the expected Hong Kong dollar cost of buying the same amount of ringgit if you decide to hedge using forward contract. [2 marks] (iii) At what spot exchange rate in the coming three month's time, will you be indifferent between the forward and option market hedges? [4 marks]
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