A Zimbabwean exporting firm Socrates Limited expects to receive Botswana Pula, BWP XXXXXXXXXXfour million eight hundred thousand Pula) in 6 months’ time but is worried about adverse movements in...

A Zimbabwean exporting firm Socrates Limited expects to receive Botswana Pula, BWP 4 800 000 (four million eight hundred thousand Pula) in 6 months’ time but is worried about adverse movements in exchange rate and wants to hedge against this development. Suppose that Socrates Limited has gathered the following financial information from the two countries’ markets:

- Spot exchange rate= $0.1864/BWP;

- Three months’ forward rate =$0.1854/BWP

- Zimbabwe’s borrowing interest rate= 16% p.a.;

- Zimbabwe’s lending interest rate =12% p.a.;

- Botswana’s borrowing rate=20% p.a.;

- Botswana’s lending rate= 15% p.a.;

- The three months’ forecast spot exchange rate = $0.1848/BWP.

Demonstrate how the firm can hedge its Pula exposure using forward and option market hedges assuming that the three months’ put option contract on the counter (OTC) market for BWP4 800 000 (four million eight hundred thousand Pula) has a strike price of $0.1880/BWP and a premium of 1.80%.