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You are the corporate treasurer of a small Australian-based manufacturing company that has just taken...

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Finance

You are the corporate treasurer of a small Australian-based manufacturing company that has just taken on a very large contract to produce aluminium engine casings for a large US-based corporation. Your chief executive has guaranteed a fixed price on the casings over the first two years of the contract. You are greatly concerned about the possibility of increases in the USD price of aluminium, due to increases in its use in the automotive and power transmission industries.

(a) Briefly outline the exposures that you face on the input cost side of this contract over the next two years. Use appropriate diagrams to indicate your exposure to both the USD cost of aluminium and to the USD/AUD exchange rate. (6 marks)

(b) Explain how you could use options to hedge against the risks that your company faces from its purchase of aluminium. Again use appropriate diagrams to indicate both your exposure to and the impact of your hedge on the USD cost of aluminium. (8 marks)

(c) Should you really hedge the foreign exchange risk that you face on the USD/AUD exchange rate given that both your revenues and inputs are in USD? (6 marks)

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