International Finance

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International Finance

Main Attempt

Phase Test

Section A: Please answer ALL questions from this Section. (Section A: Total 70 marks)

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 contractor 2) an OTC option to hedge this exposure.

Current market rates and quotes are as follows:

Spot                            €1.14/£

6 Month Forward       €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 of use 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 of raw 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                             $1.30/£

3-month Forward        $1.28/£

Currency futures: CME £62,500 September 2018 Contract (cash-settled): $1.26/£

Interest rates (borrowing and lending):           UK      4% per annum

US       2% per annum

Required:

a) Evaluate the outcome of the two alternative hedging methods in 3 months’ time if exchange rates have moved to:

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]