International Finance
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International Finance
April 2021 – Main Attempt
Phase Test
Question 1
Finham Limited UK has just signed a contract for the sale of a new manufacturing equipment for €400,000 to an Italian company. The receipt is expected in six months’ time. The company’s finance director is considering using either 1) a forward contract or 2) an OTC option to hedge this exposure.
Current market rates and quotes are as follows:
Spot
6 Month Forward
€1.14/£
€1.16/£
An option to sell €400,000 in six months’ time at an exercise price of €1.14/£ is available from their bank at a premium of £0.02 per €
Required
a) In each case compare the results if in six months’ time the exchange rate has
i) Moved to €1.10/£
[15 marks]
ii) Moved to €1.18/£
[15 marks]
b) Calculate the exchange rate at which it would be beneficial to use the option rather than the forward. Explain why this information would be ofuse to a company.
[5 marks] [Total: 35 marks]
Question 2
Stoneleigh Limited, a UK manufacturing company, has just signed a contract on 1st June 2018 to import $1,000,000 ofraw materials from a US company. The payment is due in three months’ time. The board of Stoneleigh Limited expect a steep depreciation of Sterling against $, hence they are considering two alternative ways to hedge their exposure.
1) A forward hedge
2) A futures hedge
Market Data at 1st June 2018:
Exchange rates: Spot
3-month Forward
$1.30/£
$1.28/£
Currency futures: CME £62,500 September 2018 Contract (cash-settled): $1.26/£
Interest rates (borrowing and lending):
Required:
UK 4% per annum
US 2% per annum
a) Evaluate the outcome of the two alternative hedging methods in 3 months’ time if exchange rates have moved to:
i)
iii)
$1.24/£
[10 marks]
$1.36/£
[10 marks] Your answer should include both a numerical and a written summary and evaluation.
b) The company’s financial manager also proposes the use of money market hedging, i.e. a synthetic forward.
i) Explain how the company would use a money market hedge based on the above market data.
[10 marks]
ii) Calculate the effective exchange rate and evaluate the outcome against your answer in a).
[5 marks] [Total: 35 marks]
Section B: Please choose ONE question from this Section. (Section B: Total 30 marks)
Question 3
A U.S. firm holds an asset in France and faces the following scenario:
|
State |
Probability |
Spot Rate |
P* |
|
1 |
30% |
$1.40/€ |
€980 |
|
2 |
40% |
$1.50/€ |
€1,000 |
|
3 |
30% |
$1.60/€ |
€1,070 |
where,
P* = Euro price of the asset held by the U.S. firm
Required
a) What is the expected value of your asset in US dollar?
[10 marks]
b) Estimate your exposure to the exchange risk.
[20 marks] [Total: 30 marks]
Question 4
Firm A is a U.S. MNC and wants to borrow €40 million for 3 years. Firm B is a French MNC and wants to borrow $60 million for 3 years. Firm A wants finance euro denominated asset in Italy and therefore wants to borrow euro. Firm B wants to finance a dollar denominated asset and therefore wants to borrow dollars. Firm A can borrow dollar at 7% or borrow euro at 6%. Firm B can borrow dollar at 8% or borrow euro at 5%. The current exchange rate is $1.50 = €1.00. If firms A and B knew and trusted each other, they could theoretically cut out the swap bank.
Required:
Develop a currency swap in which both firms A and B have equal cost saving.
[Total: 30 marks]
2022-03-05