STQ6D: [NBAA: P17 INTERNATIONAL FINANCE MAY 2003 Q4b]b) Suppose the interest rate on £ is 15% in London, and the interest rate on a comparable Tanzanian shilling investment in Dar Es Salaam is 10%.
37
INTERNATIONAL FINANCE
SELF-TEST QUESTIONS
The following spot rates are observed in the foreign exchange market:
______________________________________________________________________________________Currency Units Required to Buy One US DollarBritain (Pound) 0.62
Japan (Yen) 140.0
Europe (Euro) 0.90
______________________________________________________________________________________
On the basis of this information, compute to the nearest second decimal the number of
British pounds that can be acquired for Us $ 100
Euros that can be acquired for U.S $ 40
U.S dollar that 200 Euros can buy
U.S dollars that 1,000 Japanese yen will buy
Given below are spot and forward rates expressed in U.S dollars per unit of the Euro and ₤
Rates € ₤
Spot 1.5393 1.6030
30-days forward 1.5406 1.6006
60-days forward 1.5425 1.6000
90-days forward 1.5431 1.5945
180-days forward 1.5478 1.5859
Required:
Is the 90 day forward € quoted at a discount or at a premium?
Is the 90- day forward contract in pound trading at a discount or at a premium?
Relative to the pound is the 180 – day forward dollar quoted at a discount?
Relative to the Euro is the 90 – day forward dollar quoted at a discount?
The following quotes are received for spot, one month, three month and six month Euro (€) and Pound sterling (₤):
Spot One Month Three Six Month₤: $2.0015 – 30 19 – 17 26 – 22 42 – 35
€: $1.6963 – 68 4 – 6 9 – 14 25 – 38Required:
Convert the above swap rates in outright rates.
STQ4: [Foreign Exchange Trading]You are given the following information about currency rates for pound sterling spot and forward.
Currency | Spot | 1 Month Forward | 3 month Forward |
US (Dollar) | 1.5200 - 1.5210 | 0.32 - 0.27c pm | 0.89 - 0.84 c pm |
Canada (Dollar) | 1.8630 - 1.8640 | 0.30 - 0.20c pm | 0.90 – 0.80 c pm |
Kenya (KES) | 24.05¼ - 28.06¼ | 2⅜ - 1 ⅞c pm | 6¾ - 6¼ c pm |
Tanzania (TZS) | 2072.20 - 2079.30 | 10 - 20c dis | 45 - 55c dis |
Required:
Calculate the cost or value in pounds to a customer who wishes to:
buy US $ 1400 one month forward from his bank
buy Canadian $ 25,000 spot
buy TZS 75,000 three months forward
sell KES 28,000 one month forward
sell TZS 20,000 three months forward
sell C$ 6,000 one month forward
(a) The $: DM exchange rate is DM 1 = $ 0.35, and the DM: FF exchange rate is FF1 = DM 0.31. What is the FF: $ exchange rate?
(b) You are given the following quotes:
Australian dollar A$ 1.3806/US $
Danish Krone Dkr 6.4680/US $.
How many Australian dollars can you exchange for one krone?
(c) The €: TZS exchange rate is TZS1400 = 1€, and the TZS: £ exchange rate is : £ 0.0004 = TZS1. What is the €: £ exchange rate?
STQ6: [Cross Rates and Triangular Arbitrage]The following exchange rates are available:
Dutch guilders (f1) per US dollar fl 1.9025/US $
Canadian dollar per US dollar C $ 1.2646/US $
Dutch guilders per Canadian dollar fl 1.5214/C $
Are there any opportunities for market arbitrage? Show how a Dutch investor with fl 1000,000 can benefit from the possible arbitrage between the three markets.
Assuming no transaction costs, suppose: £1 = $ 2.4110 in New York, $ = FF 3.997 in Paris, and FF1 = £ 0.1088 in London. How would you take profitable advantage of these rates?
Suppose the direct quote for sterling in New York is 1.7110-5. What is the direct quote for dollars in London?
Suppose the spot quote on the EURO in New York is $ 1.3302-10, and the spot quote on the £ is $ 1.9180-90
What is the direct spot quote for the £ in Frankfurt?
Compute the percentage bid-ask spreads on the £ and the EURO.
Suppose the : £ is quoted in Dar es Salaam at
Buying Selling
2510/= 2600/=
while the EURO is quoted at
Buying Selling
1400/= 1440/=
What is the direct quote for the £ in Frankfurt?
STQ8: [NBAA: P17: INTERNATIONAL FINANCE - NOVEMBER 2007 Q1b]
a) Alawi Company Ltd., an importer based in Tanzania, is planning to import a multipurpose machine from South Africa at a cost of ZAR5,000,000. The company can avail loans at 18% interest per annum with which it can import the machine. However there is an offer from the Durban branch of a Tanzanian based bank extending credit of 180 days at 2% per annum against the opening of an irrevocable letter of credit. Other information is as follows:
Current exchange rate TAS/ZAR 50 - 55
180 days forward rate TAS/ZAR 48 - 50
Commission charges for letters of credit are at 2% for 12 months. No interest is charged on commission charges. Should Alawi Company Ltd. decide to accept the offer, a forward market cover can be taken for the purchase or sale of the ZAR at the end of the credit period.
REQUIRED:
Advise whether the offer from the foreign branch should be accepted. (8 Marks)
STQ9: [NBAA: P17: INTERNATIONAL FINANCE -MAY 2007 Q2a]
A commercial bank in Dar es Salaam, Tanzania, provided the following foreign exchange quotes on 30th April, 2006.
TZS/£ | £/Euro | TZS/US$ | |
Spot | 2404 – 2420 | 0.4852 – 0.4892 | 1050 – 1060 |
1 Year Forward | 2456 – 2474 | 0.4956 – 0.4966 | 1200 – 1260 |
REQUIRED:
How many TZS will the bank pay to purchase one Euro one year forward from a customer? (2.5 marks)
Determine the one year forward percentage bid-ask spread on the £ against the US$ (2.5 marks)
Calculate the spot and one year forward mid-prices for the £ against the Euro and determine the one year forward premium or discount on the Euro against the £. (3 Marks)
Mango Enterprises Ltd. (MEL) is an import-export company based in Dar Es Salaam. On February 28th, the company contracted to buy 1,500 tons maize from Malawi at a price of Kwacha 11,820 per ton. MEL has arranged that shipment of the product will be made directly to a customer in Uganda who has bought the maize at Ushs. 4620 per ton. Of the total quantity, 500 tons will be shipped during March and the balance by the end of April. Payment to the suppliers is to be made immediately on shipment, whilst one month credit from the date of shipment is allowed to the Ugandan customer. Assume MEL arranges with its bank to cover these transactions in Tshs. on the forward exchange market for which the exchange rates as at 28th February being those given below:
Kwacha Ushs.
Spot 1.0745 -1.0775 3.84- 3.881 month forward 5½ - 10½ c dis 2½ - 1½ c premium
2 months forward 7½ - 17½ c dis 4 – 3 c premium
3 months forward 10.6 – 25 c dis 6½ - 5½ c premium
The bank charges an exchange commission of Tshs. 10,000 on each transaction.
Required: Calculate the profit or loss MEL will make on the transaction (10 Marks)
STQ11: [NBAA: P17: INTERNATIONAL FINANCE NOV. 2004 Q2a]
A foreign exchange dealer provided the following quotations for the South-African Rand (SAR) against the Tanzanian shilling (TZS) on the 31st September 2004:
TZS/SAR Spot 50 – 55
Three Months Forward 2 – 7 dis.
Required:
(i) Calculate the percentage bid-ask spread on the three month forward TZS (2.5 Marks)
(ii) Calculate the profit made by the dealer in purchasing and selling SAR1,000,000 three month forward. (2.5 Marks)
(iii) Using the spot and forward offer prices calculate the forward premium/discount on the
SAR (2.5 Marks)
STQ12: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2003, Q3a]
Define a Forward Exchange Contract and explain the following terms
Par
Discount
Premium
in relation to the forward exchange contracts
STQ13: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2002: Q4b]
b) Given the following market rates expressed in European terms of other currency’s units per US Dollar:
US$:Lit Spot 1,890.00 – 1,892.00
One Month Forward 1,894.25 – 1,897.50
US$:Dfl Spot 3.4582 – 3.4600
One Month Forward 3.4530 – 3.4553
Required:
Calculate the Forward Cross Rate for buying and selling Italian Lire (Lit) against the Dutch Guilders (Dfl.)
PARITY RELATIONSHIPS IN INTERNATIONAL FINANCE
STQ1: [THE PURCHASING POWER PARITY] STQ1A: [THE LAW OF ONE PRICE]Two countries, Tanzania and Kenya produce only one good, wheat. Suppose the price of wheat in Tanzania is TZS325 and in Kenya is KES135
According to the law of one price, what should the TZS/KES spot exchange rate be?
Suppose the price of wheat over the next year is expected to rise to TZS350 in Tanzania and KES160 in Kenya. What should the one year TZS/KES exchange rate be?
STQ1B: [THE PURCHASING POWER PARITY: RELATIVE VESION]
The Tanzania and Britain are running annual inflation rates of 20% and 2% respectively. The initial exchange rate is ₤ 1= 2000/= Calculate the value of the ₤ in 2 years (Assume the PPP holds)
STQ1C: [THE PPP: RELATIVE VERSION]The U.S Price level is at 112 while the German Price level is at 107 relative to the base price levels of 100. If the initial value of the DM (at price level of 100) was $ 0.48 calculate the dollar value of the DM according to the PPP.
STQ2: [THE INTEREST RATE PARITY]STQ2A: [COVERED INTERES ARBITRAGE]
Suppose the interest rate on £ is 12% in London, and the interest rate on a comparable dollar investment in New York is 7%. The £ spot rate is $1.75 and the one-year forward rate is $ 1.68. Are there opportunities for covered interest arbitrage? Illustrate the profits associated with covered interest arbitrage by showing the steps that an arbitrageur can take to profit from the discrepancy in rates based on $1,000,000 transaction. Assume that the borrowing and lending rates are identical and the bid–ask spread in the spot and forward market is zero.
STQ2B: [COVERED INTERES ARBITRAGE]
Here are some prices in the international foreign exchange and money markets:
Spot rate TZS 750/DM
Forward Rate (one year) TZS 770/DM
Interest Rate (DM) 7% per year
Interest Rate (TZS) 9% per year
Assuming no transaction costs or tax exist do covered arbitrage profits exist in the above situation? Describe the flows.
STQ2C: [COVERED INTEREST ARBITRAGE]Are arbitrage gains possible from the following set of information to the arbitrageur?
Spot Rate TZS47.88/SAR
3 Month Forward Rate TZS48.28/SAR
3 Months Interest rates: TZS 7% pa
SAR 11% pa
STQ3: [FISHER EFFECT & THE INTERNATIONAL FISHER EFFECT]STQ3A: [THE FISHER EFFECT]If expected inflation is 100% and the real required return is 5% what will the nominal-interest rate be according to the Fisher effect?
STQ3B: [THE INTERNATIONALFISHER EFFECT]1. In July the one–year interest rate is 4% on Swill francs and 13% on US dollars.
If the current exchange rate is SFr1=$0.63 what is the expected future exchange rate in one year?
If a change in expectations regarding future US inflation causes the expected future spot rate to rise to $0.70 what should happen to the U.S. interest rate according to the International Fisher Effect?
2. If the $:¥spot rate is $1=¥218 and interest rates in Tokyo and New York are 6% and 12% respectively, what will be the expected $: ¥ exchange rate one year hence.
STQ4: [FORWARD RATES AS UNBIASED PREDICTORS OF FUTURE SPOT RATES] [FORECASTING FUTURE SPOT RATES]
If the 90-day forward rate is EURO1=$ 1.5987, what is the expected value of the EURO in 90 days (use the UFR to forecast the future $/EURO spot rate).
STQ5: [INTERRELATIONSHIPS AMONG PARITIES] STQ5A: [FISHER EFFECT AND INTEREST RATE PARITY]Suppose that in Japan the interest is 8% and inflation is expected to be 3%. Meanwhile the expected inflation rate in France is 12% and the English interest is 14%. To the nearest whole number, what is the best estimate of the one year forward exchange premium(discount) at which the pound will be selling relative to the French franc?
STQ5B: [FISHER EFFECT AND THE PPP]
Due to integrated nature of their capital markets, investors in both the United State and U.K. require the same real interest rate 2.5%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3.5% in the United State and 1.5% in the U.K. for the next three years. The spot exchange rate is currently $1.50/£.
REQUIRED:
Compute the nominal interest rate per annum in both the Unites State and U.K., assuming that the Fisher Effect holds.
What is your expected future spot dollar-Pound exchange rate in three years from now?
Can you infer the forward dollar-pound exchange rate for one-year maturity?
STQ6A: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2006: Q1b, 4a]
NOVEMBER 2006: Q1b
‘If all securities markets are fully integrated, securities of comparable expected returns and risk should have the same required rate of return in each national market after adjusting for foreign exchange risk and political risk. This applies to both equity and debt, although it often happen that one or the other may be more integrated than its counterpart.’
REQUIRED:
Based on this statement, critically explain what is your understanding of capital market segmentation is. (12 marks)
NOVEMBER 2006: Q4a
It is now the beginning of year 2006. The spot bid rate for the US Dollar is TZS1240 while the spot bid -ask spread is TZS15. A forecaster provides the following forecasts for the bid-ask spread and inflation rates for Tanzania and United States in the next four years.
YEAR 2007 2008 2009 2010
BID-ASK SPREAD [TZS] 23 27 30 45
FORECAST RATE OF INFLATION
TANZANIA 6% 5% 4% 3.5%
UNITED STATES 3.5% 3% 3% 2.5%
REQUIRED:
On the basis of the bid-ask spread forecasts and the theory of PPP determine the expected exchange rates and the percentage bid ask-spread for the years 2007-2010. (12 marks)
STQ6B: (NBAA: P17: INTERNATIONAL FINANCE: MAY. 2006, Q4b)
Suppose annual inflation rates in the U.S. and Brazil are expected to be 5% and 90% respectively over the next year. If the current spot rate for the Brazilian Cruzeiro is 3342.62 Cruzeiros per dollar, what is the best estimate of the Cruzeiro’s future spot rate one year from now? (3 Marks)
STQ6C: (NBAA: P17: INTERNATIONAL FINANCE: NOV. 2004, Q4b)
Define the Purchasing Power Parity Theory and discuss the problems it faces when applied in practice. (7 Marks)
STQ6D: [NBAA: P17 INTERNATIONAL FINANCE – MAY 2003 Q4b]
b) Suppose the interest rate on £ is 15% in London, and the interest rate on a comparable Tanzanian shilling investment in Dar Es Salaam is 10%. The £ spot rate is TZS1,750 and the one-year forward rate is TZS1,680.
REQUIRED:
Are there opportunities for covered interest arbitrage? Show relevant computations. (2 Marks)
Is there covered interest differential in favor of London or Dar Es Salaam? (2 Marks)
Illustrate the profits associated with covered interest arbitrage by showing the steps that a Tanzanian arbitrageur can take to profit from the discrepancy in rates. Assume that the borrowing and lending rates are identical and the bid–ask spread in the spot and forward market is zero. (5 Marks)
SELF-TEST QUESTIONS ON EFFICIENT MARKETS AND EXCHANGE RATE FORECASTING
STQ 1: [PARITY RELATIONSHIPS AND EXCHANGE RATE FORECASTING]
STQ1A: [FORECASTING EXCHANGE RATES USING THE IFE]
i) Suppose five-year interest rates on the US$ and Euro are 12% and 8% respectively. If the current spot rate for the Euro is US$1.40 forecast the value of the Euro in five years.
ii) A forecaster provided the following forecasts for interest rates in Tanzania and UK.
YEAR 2007 2008 2009 2010 2011
TANZANIA 25.6 25.1 28.4 38.3 39.0
UNITED KINGDOM 11.4 8.5 5.4 6.8 6.7
REQUIRED:
If the exchange rate at the end of 2006 is TZS2300 forecast the TZS value of the pound for the years 2007-2011.
STQ1B: [FORECASTING EXCHANGE RATES USING THE PPP]
The current spot bid rate for the US Dollar is TZS1240. The spot bid ask spread is TZS15. A forecaster provided the following forecasts for the bid ask spread in the next four years.
YEAR 1 2 3 4
BID-ASK SPREAD [TZS] 23 27 30 45
REQUIRED:
On the basis of the bid-ask spread forecasts and the theory of PPP determine the expected exchange rates in years 1-4 years given that the annual inflation rates in Tanzania and US are expected to be 9% and 2.5% respectively.
STQIC: [ESTIMATING FORWARD RATES USING THE IRP]
Money and foreign exchange markets in London and New York are very efficient. You have the following information:
LONDON NEW YORK
Spot Exchange Rate $1.6000/£ £0.6250/$
One Year Treasury Bill Rate 5.00% 6.00%
Expected inflation Rate 2.00% Unknown
REQUIRED:
Assuming parity conditions hold:
Estimate the inflation rate in the United States next year
Estimate the one year forward rate between pounds and dollars in London and New York.
STQ2: [EXCHANGE RATE FORECASTING AND SPECULATION]
STQ 2A: [UNCOVERED INTEREST ARBITRAGE AND SPOT SPECULATION]
It is the end of September 1994. The current TZS/US$ exchange rate is 1352.60, the Tanzanian and US three month interest rates are 6% and 4.5% p.a. respectively. A forecast indicates that the exchange rate at the end of 1994 will be 1285.00.
REQUIRED:
Assuming that you strongly believe in the forecast provided by the forecaster, what would you do on the basis of this information?
Forecast the exchange rate at the end of 1994 using the IRP
If the actual exchange rate turns out to be 1365.00. Calculate the percentage forecasting error.
Is there an error of direction in this forecast?
How much loss will be incurred by acting on this forecast?
STQ2B: [EVALUATING FORECASTING PERFORMANCE]
You are hired as a consultant to assess the firm’s ability to forecast. The firm has developed a point forecast for two different currencies. It wants to determine which currency was forecast with greater accuracy. The following information was provided:
Period | Yen Forecast | Actual Yen Value | Pound Forecast | Actual £ Value |
TZS500 | TZS510 | TZS2000 | TZS1800 | |
TZS450 | TZS460 | TZS2200 | TZS2300 |
REQUIRED:
Which currency was forecast with greater accuracy? Use the MAE, MSE, and RMSE methods.
STQ3: [EXAMINATION TYPE QUESTIONS]
STQ3A: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2007: Q1b]
The current spot exchange rate is TZS/€ 1550 – 1560 and the three-month forward rate is TZS/€ 1500 – 1511. On the basis of your analysis of the exchange rates, you are very confident that the spot exchange rate will be TZS/€ 1520 – 1533 in three months. Assume that you would like to buy or sell €100,000.
REQUIRED:
What actions do you need to take to speculate in the forward market? What is the expected TZS profit from the speculation? (4 marks)
What would be your speculative profit in TZS terms if the spot exchange rate actually turns out to be TZS/€ 1510 – 1522? (2 marks)
STQ3B: [NBAA: P17: INTERNATIONAL FINANCE: MAY. 2005, Q5a]
Explain briefly the main activities involved in fundamental forecasting of exchange rates. What are major limitations of fundamental forecasting? (7 Marks)
STQ3C: [NBAA: P17: INTERNATIONAL FINANCE: NOV. 2004, Q2b]
You are financial analyst working with a subsidiary of British Company in Tanzania. Your managing director has received forecasts of Pound Sterling exchange rates in two year’s time from three leading banks in Tanzania.
TZS/£ Two Year ForecastsNational Bank of Commerce (NBC) 1,452
Co-operative and Rural Development Bank (CRDB) 1,514
National Micro-Finance Bank (NMB) 1,782
The current spot mid-rate is TZS1,667/£
A non-executive director of your company has suggested that in order to forecast future exchange rates, the interest rate differential between countries should be used. She stated that “as short-term interest are currently 6% in the UK, and 3.5% in Tanzania, the exchange rate in two years time will be TZS1,748.50/£”.
REQUIRED:
You are financial consultant. Prepare a brief report discussing the likely validity of the non-executive director’s estimate. (5 Marks)
Explain briefly whether or not forecasts of future exchange rates using current interest rate differential are likely to be accurate. (5 Marks)
Based on your answer to i) above calculate the percentage forecasting error should the actual exchange rate in two years turn to be TZS1,700/£ (2.5 Marks)
STQ3D: [NBAA: P.17 INTERNATIONAL FINANCE – MAY 2003 Q4]
a) Foreign exchange rate forecasts can be used for strategic policy decisions, budgeting and exposure management
Required:
Outline the following theories of exchange rate determination:
Purchasing Power Parity (2.5 Marks)
The Monetary Theory (2.5 Marks)
Explain how forecasts would be made using each of the above theories and identify possible problems and weaknesses in each case. (6 Marks)
FINANCIAL MARKETS AND FINANCIAL INSTRUMENTS (DERIVATIVES)
QUESTION 1: [STOCK MARKET AND STOCK MARKET RATIOS]QUESTION 1A: [STOCK MARKET INFORMATION]
A Financial Magazine in Tanzania reported the following information on shares traded in the Dar Es Salaam Stock Exchange for the Year 1999:
1999 High Low | Stock | Price | + or - | Div. Net | Cover | P/E Ratio |
243 152 | D Co. | 221 | -2 | 5.25 | 4.0 | 10.5 |
333 220 | P Co. | 255 | 8.25 | 2.5 | 12.1 | |
265 138 | R Co. | 203 | 18 | 2.75 | 5.3 | 13.9 |
What does the High/Low refers to?
What does + or – show?
Calculate the Dividend Yield for Each Company assuming a basic income tax rate of 25%.
Calculate the EPS for each company
QUESTION 1B: [STOCK MARKET RATIOS]
Kassim Company is an investment company whose investments in other companies range from small holdings of shares or loan capital to complete holdings. As a senior manager in Kassim Company you have been asked to study the following most recent published statements of Eddy Company with a view to deciding whether to invest in any of its securities.
EDDY COMPANY
SUMMARY PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31.12.1992
Profit Before Taxation TZS1,660,000
Corporation Tax TZS580,000
Profit After Taxation TZS1,080,000
Preference Dividend TZS 35,000
TZS1,045,000
EDDY COMPANY
SUMMARY BALANCE SHEET AS AT 31.12.1992
Net Fixed Assets TZS11,500,000
Net current Assets TZS1,200,000
TZS12,700,000
Financed By:
Authorized, Issued and Fully Paid:
7,000,000 Ordinary TZS1 Shares TZS7,000,000
500,000 7% Cumulative TZS1 Preference Shares TZS500,000
TZS7,500,000
Reserves TZS700,000
TZS8,200,000
Loan Stock:
8% Debentures (TZS100 par) TZS1,000,000
7% Unsecured loan Stock (TZS100 par) TZS2,000,000
9% Convertible loan Stock 2002/2004 (TZS100 par) TZS1,500,000
TZS12,700,000
Notes
At the balance sheet date the market values of the securities of Eddy Company were as follows:
The ordinary shares ha a market value of TZS1.50 each ex div.
7% preference shares TZS1.07 each ex-div.
8% debentures 96 per cent ex interest
9% convertible loan stock 82 per cent ex interest
Proposed ordinary dividend (Net of Income Tax) TZS700,000. The forecast pre tax profits for the next 12 months will be 7% higher than in the previous year. The fixed assets are estimated to be worth TZS13,000,000. The income tax rate is 25%. The 8% Debentures are redeemable at par in 2 years time. The 7% unsecured loan stock 57% ex interest.
REQUIRED:
Carry out an analysis of the following financial features which should be considered before any decision is taken by Kassim Company to invest in all or any of the Eddy share or loan capital.
Earnings per Share (EPS)
Price Earnings Ratio (P/E Ratio)
Dividend Yield on the Ordinary Shares
Dividend Cover
Yield to Maturity on the 8% Redeemable Debentures.
QUESTION 2A: [CURRENCY FUTURES: DAILY SETTLEMENT PROCESS]
On Tuesday morning, an investor takes a long position in a Swiss Franc futures contract that matures on Thursday afternoon. The agreed upon price is US$0.75 for SFr 125,000. At the close of trading on Tuesday, the futures price has risen to US$0.755. At Wednesday close, the price has declined to US$0.752. At Thursday close, the price drops to US$0.74 and the contract matures.
REQUIRED:
Detail the daily settlement process. What will be the investor’s profit or loss?
QUESTION 2B: [CURRENCY FUTURES: DAILY SETTLEMENT PROCESS]
On Monday morning, an investor takes a short position in Euro futures contract that matures on Wednesday afternoon. The agreed upon price is US$0.6370 for Euro 125,000. At the close of trading on Monday, the futures price has fallen to US$0.0.6315. At Tuesday close, the price falls further to US$0.6291. At Wednesday close, the price rises to US$0.6420 and the contract matures.
REQUIRED:
Detail the daily settlement process. What will be the investor’s profit or loss?
QUESTION 2C: [CURRENCY FUTURES: TAKING DELIVERY OF UNDERLYING CURRENCY]
An American importer of Australian beef bought two Australian dollar (A$) futures contracts currently priced at US$0.7655 at the time when the spot exchange rate was US$0.7525.REQUIRED:
- Calculate the value of the two contracts.
Suppose that during the period between the initiation of the contract and the date of delivery, the A$ appreciates and so the spot exchange rate rises to US$0.7800, while the rate implicit in the futures contract is US$0.7940. Calculate the gain made by the importer.
QUESTION 2D: [SHORT-TERM INTEREST RATE FUTURES: TREASURY BILL FUTURES]
The 90-Day T-Bill contract traded on the International Monetary Market (IMM, a part of the Chicago Merchantile Exchange) calls for delivery of a US Treasury Bill with face value of US$1,000,000 and 90 Days to maturity. The delivery months are March, June, September and December.
REQUIRED:
Suppose the settlement price on the last trading day is 91.45, calculate the following:
The Discount Yield on the US Treasury Bill
The amount the a trader who has an open long position in one T-Bill contract will have to pay
The change in contract value caused by a movement of 1 basis point (1/100th of 1%)
The profit one would (ignoring marking to market) if he closes his position by selling a contract at a later date when the futures price is 92.05.
QUESTION 2E: [SHORT-TERM INTEREST RATE FUTURES: TREASURY BILL FUTURES]
The given table below presents an extract from the Wall Street journal Europe of 26 February 1992, giving the prices of T-Bill Futures on the IMM for February 25.
T-Bill Futures Prices.
Tresury Bills (IMM) – US$1 Million; pts. of 100%
Open | High | Low | Settle | Chg | |
March | 96.04 | 96.09 | 96.01 | 96.02 | -- |
June | 95.79 | 95.91 | 95.79 | 95.81 | +.04 |
September | 95.48 | 95.62 | 95.48 | 95.54 | +.07 |
December | 94.97 | 95.06 | 94.94 | 95.00 | +0.06 |
REQUIRED:
What does the column headed Chg give?
Calculate the amount to be credited to the margins account of a trader holding a long open position in one June contract.
Calculate the amount to be credited to the margins account of a trader holding a short open position in one September contract.
QUESTION 2F: [LONG -TERM INTEREST RATE FUTURES: BOND FUTURES]
In the following table an extract from the Chicago Board of Trade (CBT)-Bond Futures quotations. The notional asset underlying the CBT T-Bond contract is a 8% coupon bond with 20 years to maturity from the date of delivery. Study the table and answer the questions that follow.The Wall Street Journal, Europe, 26 February 1992.
Treasury Bonds (CBT) – US$1,000,000; pts 32nds of100%
Open | High | Low | Settle | Chg | Yield Settle | Chg | |
March | 99-10 | 100-04 | 99-09 | 99-23 | +11 | 8.028 | -.035 |
June | 98-08 | 99-01 | 98-08 | 98-21 | +11 | 8.137 | -.036 |
September | 97-09 | 98-00 | 97-09 | 97-21 | +11 | 8.241 | -.036 |
December | 96-14 | 97-03 | 96-14 | 96-24 | +11 | 8.337 | -.036 |
What does the settlement price of 99-23 for the March contract really means?
What does the +11 under the column headed Chg for the month of March mean?
What is the size of the tick in this case? Calculate the change in the value of the contract represented by the tick and the increase in the settlement price on February 25.
What do the columns headed Yield Settle and the next column give?
A US importer has a Euro 62,500 payment to make to a German exporter in 60 days. The US importer is thinking of buying a call option to have the DM delivered to it at a strike price of US$0.64 per Euro at the end of the 60 days in order to protect against the risk of raising Euro. The premium is US$0.02 per Euro.
REQUIRED:
If at the time the importer’s payment falls due, the value of the Euro has risen to US$0.70, what is the gain or loss on the call position?
If at the time the importer’s payment falls due, the value of the Euro has fallen to US$0.60, what is the gain or loss on the call position?
Ford Ltd buys a French Franc Put Option (Contract Size FF250,000) at a premium of US$0.01 per franc.
REQUIRED:
If the exercise rice is US$0.21 and the spot price of the franc at the date of expiration is US$0.216, what is Ford’s profit or loss on the put position?
QUESTION 3C: [CURRENCY OPTIONS: PAYOFFS: CALL - PUT OPTIONS COMBINED]A trader holds a call option and a put option on the Australian dollar. The following information is available:
Amount A$1,000,000
Price of Call US$0.03 (per unit of the A$)
Price of Put US$0.05 (per unit of the A$)
Exercise Exchange Rate of Call US$0.75/A$
Exercise Exchange Rate of Put US$0.75/A$
REQUIRED:
Calculate the Net Pay Off on the Long Call, Long Put and Combined Position at the following exchange rates: US$0.80; US$0.65
Calculate the Net Pay Off on the Short Call, Short Put and Combined Position at the following exchange rates:
US$0.80
US$0.65
QUESTION 5
QUESTION 5A: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2006, Q3a]
NOVEMBER 2006: Q3a
a) Briefly explain the meaning of currency options and their main uses and major drawbacks (6 Marks)
(b) Answer the following short questions. Show your computations:
(i) On June 10, the closing rate of French Francs was $0.18. Puts which would mature on September 19 with a strike price of $0.19, were traded at $0.08. What was the intrinsic value of the call on June 10?
(ii) The premium for a call on British Pound with a strike price of $1.75 is $0.07. What is the break even point in $ for the buyer of the call?
(iii) A U.S. company wants to use a currency put option to hedge 15 million French Francs in account receivable. The premium of the currency put option with a strike price of $0.22 is $0.07. What is the total amount of Dollars received after accounting for the premium payment if the option is exercised?
(iv) The call premium per Canadian Dollar on April 19 is $0.04, the expiration date is September 19 and the price is $0.80. K. Y. John purchased three call options for Canadian Dollars [Can S150,000]. He decides to let his options expire unexercised on September 19 because the spot rate for the Canadian Dollar fell to $0.70 on that day. What is his total loss from this speculation?
(v) The spot rate is US$0.50 per deutsche Mark. The annual interest rates are 12 percent for the United States dollar and 8% for the Germany Deutsche Mark. If these interest rates remain constant, then what is the market forecast of the spot rate for the Deutsche Mark in five years?
[10 Marks]
QUESTION 5A: [NBAA: P17: INTERNATIONAL FINANCE, MAY 2004, Q2]
The following information relates to the ordinary TZS1,000 shares in Temboni Company, a newly quoted company in the stock exchange. The basic rate of income tax is 25% and the ordinary dividend has just been paid. Temboni Company is all equity financed.
Earnings per Share (EPS) TZS450
Dividend per Share (Net) TZS150
Gross Dividend Yield 3.8%
Dividend Cover 3
P/E Ratio 12
REQUIRED:
Explain the importance for investors of each of these terms. (7.5 Marks)
Calculate the share price which is likely to have accompanied the above data and explain the relationship between this price and the nominal value of the shares of TZS1,000. (5 Marks)
List and discuss briefly possible reasons why companies in the same type of business may have different P/E Ratios. (7.5 Marks)
Two counter parties agree to enter into a foreign currency swap between American dollars and Swiss francs. One dollar is currently worth 1.4 francs. The American dollar payer will provide $500,000. The interest rate on the dollar is 9%, and the Swiss franc rate is 8%. The swap calls for a life of three years with annual payments.
REQUIRED:
How much will the provider of the dollar pay at the outset? (2 marks)
If the interest rates do not change, what is the annual dollar interest payment for the foreign borrower of dollars? (2 marks)
If a net payment is recorded for the interest in year one and exchange rates do not change, what will be the net payment? (3 marks)
What will be the total payment in Swiss francs by the borrower of USA dollars for year 3? (2 marks)
What will be the total payment in the USA dollars by the borrower of Swiss francs for the year 3? (2 marks)
QUESTION 5C: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2002 Q 5a]
Assume that you are a swap dealer and have just acted as a counterpart in an interest rate swap. The nominal principal for the swap was US$7.5 million and you are now obliged to make five annual payments of 8% interest. The floating rate that you will receive is 8.2%, and the floating payments to you are annual as well.
REQUIRED:
If the floating rate stays the same for the first two years and then falls by 1.5%, what will be your net payments for the five years? (5 Marks)
SELF-TEST QUESTIONS ON INTERNATIONAL CAPITAL BUDGETING STQ1A: [DOMESTIC CAPITAL BUDGETING: THE NPV METHOD]Namanga Company is considering the manufacture of a new product. The company’s Engineering Department has reported that the firm would need additional manufacturing capability and currently Namanga has an option to purchase an existing building at a cost of TZS144,000,000 which would meet this need. The building will be bought and paid for in one yea, on December 31, 1990. The necessary equipment would be purchased and installed late in 1990 and it would also be paid for on December 31, 1990. The equipment will cost TZS96,000,000. The project would require an initial investment in working capital of TZS72,000,000. The initial working capital investment would also be made on December 31, 1990.
The project’s economic life is four years. At the end of that time, the building is expected to have a market value of TZS90,000,000 and a book value of TZS128,880,000, whereas the equipment would have a market value of TZS24,000,000 and a book value of TZS16,320,000 The production department has estimated that direct labour and direct material costs would total 20% and 40% of sales respectively and that fixed overhead costs, excluding depreciation, would be TZS60,000,000 a year. Depreciation charges for the building and the equipment are estimated as follows: (in ‘000 TZS)
1991 | 1992 | 1993 | 1994 | |
Depreciation Charges Building Equipment | 2,160 19,200 | 4,320 30,720 | 4,320 18,240 | 4,320 11,520 |
The corporate tax rate is 40%. Namanga cost of capital is 12%. For capital budgeting purposes, the company’s policy is to assume that the operating cash flows occur at the end of each year. The marketing manager of Namanga Co. believes that annual sales would be 240,000 units if the units were priced at TZS2000 each, so the annual sales are estimated at TZS480,000,000.
REQUIRED:
You are the Namanga’s financial analyst and you have been assigned the task of supervising the capital budgeting analysis. Evaluate and comment on the economic viability of the proposed project. (Use the NPV Method).
SUGGESTED SOLUTION: Project Evaluation The Net Present Value MethodNamanga Company Expansion Project: Net Cash Flows, 1990 – 1994 (‘000’ of TZS)
End of Year | 1990 | 1991 | 1992 | 1993 | 1994 |
Building Equipment Increase in Working Capital Sales Variable Costs Fixed Costs Depreciation (Building) Depreciation (Equipment) | (144,000) (96,000) (72,000) | 480,000 288,000 60,000 2,160 19200 | 480,000 288,000 60,000 4,320 30,720 | 480,000 288,000 60,000 4,320 18,240 | 480,000 288,000 60,000 4,320 11,520 |
Earnings Before Taxes Taxes (40%) | 110,640 44,256 | 96,960 38,784 | 109,440 43,776 | 116,160 46,464 | |
Net Income Add back Depreciation | 66,384 21,360 | 58,176 35,040 | 65,664 22,560 | 69,696 15,840 | |
Cashflow from Operations Return of NWC Requirement Net Salvage Value | 87,744 | 93,216 | 88,224 | 85,536 72,000 126,480 | |
Net Cashflow | (312,000) | 87,744 | 93,216 | 88,224 | 284,016 |
Discounting Factor at 12% | 1.000 | 0.8929 | 0.7972 | 0.7118 | 0.6355 |
Present Value | (312,000) | 78,347 | 74,312 | 62,798 | 180,492 |
NPV(in ‘000’) = 395949 – 312,000 = 83,949
Note: The Net Salvage Values, 1994 (in ‘000’ Shs.)
Building | Equipment | Total | |
Initial Cost | 144,000 | 96,000 | 240,000 |
Salvage Value Book Value | 90,000 128,880 | 24,000 16,320 | 114,000 145,200 |
Gain or Loss on Sale Taxes (40%) | 38,880 15,552 | 7,680 3,072 | 46560 18624 |
Net Salvage Value | 105,552 | 20,928 | 126480 |
A UK Engineering Company has been exporting to the Netherlands for a number of years, and the company is considering establishing an engineering subsidiary in Netherlands. The project is expected to generate the following additional cash flows in guilders:
YEAR | ||||||
Expected Cash Flow in 000s € | -600 | 400 | 450 | 510 | 575 | 650 |
The UK company's cost of capital is 16%, and the risk free rate of interest in the UK r£ is 8%, and in the Netherlands, r€l is 9% (note that according to the International Fisher Effect that if the real interest rates are the same in the two countries then this implies Dutch inflation is 1% higher than in the UK). The current spot exchange rate is £1 = 2€. Assume that the PPP and the IRP hold.
REQUIRED:
Provide reasons that could lead the UK Company considering the establishment of an Overseas Subsidiary.
Evaluate the Proposed Project.
A US firm is considering an investment in Tanzania, which will cost TZS200 million and is expected to produce an income of TZS30 million in real terms in each of the next 7 years. The firm estimates that the appropriate cost of capital for the project is 8%. Annual interest rates are 9% in Tanzania, 7⅞% in the US, the spot exchange rate is TZS1354.50 per US$, and inflation in Tanzania is expected to average 6% per year. At the end of the seventh year the US firm expects to sell the Tanzanian investment to a local firm for TZS50 million.
REQUIRED:
You have been selected as the firm’s financial analyst and you have been assigned the task of supervising the international capital budgeting analysis. Evaluate and comment on the economic viability of the proposed project using the NPV method applying the following techniques:
Centralized Capital Budgeting and
Decentralized Capital Budgeting Techniques)
Gulf Company is an Italian based manufacturer of radios. The company’s senior management team has believed for several years that there is an opportunity to increase sales in the domestic market and wish to set up a manufacturing subsidiary in Tanzania. Setting up the Tanzanian subsidiary would involve construction of a new factory in Dar es Salaam. The initial project cash investment is estimated at Euro 1,000,000 divided as follows:
Fixed assets Euro 900,000
Working capital requirements Euro 100,000
Production and sales are expected to be constant at 20,000 units per annum. The average price per radio is estimated as follows:
Year 1: TZS 55,000
Year 2: TZS 53,000
Year 3: TZS 56,000
Year 4: TZS 59,000
The variable cost ratio is forecast at 30% of the selling price and is expected to remain constant. Annual fixed costs (excluding depreciation), are forecast at TZS 80,000,000. As per agreement between Gulf company and the authorities in Tanzania, depreciation expenses are not tax allowable. Inflation for each economy in the next four years is expected to be:
ITALY 4% TANZANIA 6%
The cost of capital for the company is 10%. The spot exchange rate is TZS 1400/Euro. Corporate tax in Tanzania is 30%, in Italy 40%. Tax is payable, and allowances are available, one year in arrears. The government of Tanzania is anxious to encourage foreign investment and thus allows overseas investors to repatriate an annual cash dividend equal to that year’s after tax accounting profit. Cash remitted to Italy from the subsidiary is not taxable in Italy. The after tax realizable value of the investment in four years’ time is expected to be approximately TZS 200 million.
REQUIRED:
Evaluate whether Gulf Company should establish the Tanzanian Subsidiary.
(12 marks)
EQ2: [NBAA: P17: INTERNATIONAL FINANCE: NOV. 2004 Q4a]
Hollender Company is a South-African based manufacturer of kitchen furniture. The company’s senior management have believed for several years that there is little opportunity to increase sales in the domestic market and wish to set up a manufacturing subsidiary in Tanzania. Because of high transportation costs, exporting from South Africa is not financially viable. The Tanzania subsidiary would involve the construction of a new factory in Dar Es Salaam. The projected costs are shown below:
Now TZS ‘000’ | Year 1 TZS’000’ | |
Land | 23,000 | |
Building | 16,000 | 62,000 |
Machinery | 64,000 | |
Initial Investment in Working Capital | 15,000 |
Production and sales in year two are estimated to be 2,000 kitchens at an average price of TZS200,000 (at current prices). Production and sales in each of years 3-5 is forecast at 2,500 units. Total local variable costs in Tanzania in year two are expected to be TZS110,000 per unit(at current prices). No tax allowable depreciation exists on fixed assets. All prices and costs in Tanzania are expected to increase annually by the current rate of inflation. The after tax realizable value of the investment in five years’ time is expected to be approximately TZS162 million at price levels then ruling. Inflation for each of the next six years are expected to be:
SA 3%
TANZANIA 5%
The cost of capital for the company is 10%. The spot exchange rate is TZS50/SAR. Corporate tax in Tanzania is 30%, in SA 40%. Taxation is payable, and allowances are available, one year in arrears. The government of Tanzania is anxious to encourage foreign investment and thus allows overseas investors to repatriate an annual cash dividend equal to that year’s after tax accounting profit. Cash remitted to SA from the subsidiary is not taxable in South Africa.
REQUIRED:
Evaluate whether the Tanzanian Subsidiary should be established by Hollender Company. (14 Marks)
EQ3: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2002 Q2]
Kipanga Corporation currently has no existing business in German but it is considering establishing a subsidiary there. The following information has been gathered to assess this project:
The initial investment capital required to start the project would be Euro 50 million to be used to buy plant and equipment. The plant is expected to have a useful life of 10 years and would be depreciated using a straight line method. The project would be terminated at the end of year three, when the subsidiary would be sold. Kipanga expects to receive Euros 35 million when it sells the subsidiary. This would be equal to the book value at the end of year 3. The exchange rate of the Euro is expected to be TShs 0.56 at the end of year 3. However it is estimated that the risk free interest rate in Tanzania is 12% and in German is 10%. The price, demand, and variable cost of the product in German are as follows:-
Year | Price(Euros) | Demand | Variable Cost |
500 | 40,000 units | Euro 30 | |
511 | 50,000 units | Euro 35 | |
530 | 60,000 units | Euro 40 |
The fixed costs, such as overhead expenses, are estimated to be Euro 6 million per year. All cash flows received by the subsidiary are to be sent to the parent company at the end of each year. The German government would impose an income tax of 30%. In addition, it would impose a withholding tax of 10% on earnings remitted by the subsidiary. The Tanzanian Government would allow a tax credit on remitted earnings and would not impose any additional taxes.
Kipanga requires a 20% rate of return on this project.
REQUIRED:
Should Kipanga accept the project or not? Justify your answer (22 Marks)
SELF-TEST QUESTIONS ON MANAGEMENT OF FOREIGN EXCHANGE AND INTEREST RATE RISKS
QUESTION 1: [MANAGEMENT OF TRANSACTION RISK]QUESTION 1A: [ACCA ADOPTED: HEDGING FOREIGN RECEIVABLES]: FORWARD MARKET HEDGE VS MONEY MARKET HEDGE
Bringasock Limited sells shoes to Italy. A shipment has just been made to a major Italian customer, who has been invoiced in Italian Lire, payable in three months time. The amount due is 56 million lire. Bringasock financial director has the following information about foreign exchange rates and interest rates:
Exchange Rate, Lire/£Spot 2,320 – 2,322
3 Months Forward 15 – 23 dis.
Interest Rates
Sterling Lire
Deposit Borrowing Deposit Borrowing
6% 8% 10% 12%
REQUIRED:
What course of action would you recommend to the finance director for converting the lire into sterling, so as to maximize sterling receipts from the shipment?
How your advice would differ, if at all, were Bringasock Ltd. also due to make a payment of 30 million lire to an Italian supplier, in three months?
QUESTION 1B: [CIMA ADOPTED: MODIFIED: HEDGING FOREIGN PAYABLES]: FORWARD MARKET HEDGE VS MONEY MARKET HEDGE
Runswick Ltd is an importer of clock mechanisms from Switzerland. The company has contracted to purchase 3,000 mechanisms at a unit price of 18 Swiss Francs. Three months credit is allowed before payment is due.
Current Exchange Rates
Spot SF/£ 2.97000 – 2.99000
I Month Forward 2.50c – 1.50c premium
3 Months Forward 4.50c – 3.50c premium
Current Bank Rates
Switzerland Deposit 4% Borrowing 8%
United Kingdom Deposit 8% Borrowing 12%
REQUIRED:
Explain and illustrate three policies that Runswick Ltd might adopt with respect to the foreign exchange exposure of this transaction. Recommend which policy the company should adopt. Calculations should be included where relevant. Assume that interest rates will not change during the next three months.
If the Swiss supplier were to offer 2.5% discount on the purchase price for payment within one month evaluate whether you would alter your recommendations in (a) above.
QUESTION 1C: [ACCA ADOPTED: HEDGING FOREIGN PAYABLES]: OPTIONS MARKET HEDGE
Pink Ink Company is a U.K. based exporter. It has invoiced a customer for US$350,000 payable on 1st September. The current US$/£ spot is: 1.5190 – 1.5230
It wishes to hedge its FX risk exposure using traded currency options. The £ September calls with an exercise price of US$1.50 have a premium of 8c. The £ call option contracts are in respect of £25,000. Option premiums are quoted in cents/£
REQUIRED:
Set up the option hedge and compute the option premium payable
If on 1st September, the US$/£ spot is 1.6470 – 1.6500 advise Pink Ink on whether it should allow its option to lapse or exercise them
QUESTION 1D: [HEDGING FOREIGN PAYABLES: NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2005: Q4c]: FORWARD MARKET HEDGE, MONEY MARKET HEDGE, AND OPTIONS MARKET HEDGE
Harith International Company has recently purchased a consignment of a cleaning fluid from a UK supplier for £30,000 payable in three month’s time. Recently the company has experienced foreign exchange losses on similar deals and the financial director has decided that henceforth all transaction exposure will be covered. After discussion with the company’s bank in Dar Es Salaam, the following data have been made available:Foreign Exchange Market
TZS/£ Spot Rate 1500 – 1505Three Months 1 – 2 premium
Money MarketBase rates are 18% per annum in both the UK and Tanzania. Harith International Company can borrow at 2% below the relevant base rate in either country.
Options Market
The bank has offered a call option on the £30,000 at a exercise price of TZS1,490. The option premium is TZS300,000.
REQUIRED:
Calculate the net cost of the transaction assuming it was covered in:
The forward foreign exchange market (2.5 marks)
The money market (2.5 marks)
Explain to the financial director the nature of the foreign exchange risk cover provided by a call option and calculate the exact future spot rate at which the option will start to give a cheaper cost than the forward contract. (5 marks)
QUESTION 1E: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2004: Q3b]: HEDGING FOREIGN PAYABLES: OPTIONS MARKET DEGDE]
Premier company, a Tanzanian Company, imports goods from UK and is invoiced for £216,500 payable on the 15th January. The Company wishes to hedge using current options at an exercise price of TZS1,750. Data is as follows:
TZS/£ 1,712 – 1,715
£ Options Contract Size is £12,500
March Contracts
Exercise Price | £Calls | £Puts |
1,650 | 90.25 | 40.30 |
1,700 | 80.45 | 90.80 |
1,750 | 62.50 | 95.80 |
Contract prices are in cents/£.
REQUIRED:
Show the hedge position and compute its cost. (4 Marks)
Illustrate the action the company will take on the 15th January if the TZS/£ spot rate at that time is TZS1,842 – 1,845. (5 Marks)
Calculate the Net Saving that the company makes as a result of its option hedge. (5 Marks)
A German Company exports goods to the USA and invoices its customer for US$1,522,800 payable in August. It is now June. In the foreign exchange market, the following quotations are made:
Spot US$/Euro 1.4070 – 1.4090
August Forward 1.4030 – 1.4150
September Euro futures contracts are priced at US$1.4100. (One Euro Futures contract represents Euro 108,000).
REQUIRED:
Set up the hedge position and calculate the hedge efficiency if in August the US$/Euro spot rate is US$1.4150 – 1.4170 and the September Euro Futures are priced at US$1.4150 (10 Marks)
QUESTION 1G: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2003 Q1b]
HEDGING FOREIGN RECEIVABLES: OPTIONS MARKET HEDGE
Opportunity Company is a Great Britain based exporter. It has invoiced a customer in the United States of America for US$1,1058,000 payable of 30th June.
The current US$/£ spot is 1.7296 – 1,7330
The company wishes to hedge its foreign exchange risk exposure using traded currency options. The £ June calls with an exercise price of 1.70 have a premium of 9c. the £ call option contracts are in respect of £25,000. Option premiums are quoted in cents/£.
REQUIRED:
Set up the option hedge and calculate the option cost. (Hint: Round up the required number of calls to the nearest whole number) (3 Marks)
If on 1st June, the US$/£ spot is 1.8460 – 1.8550, advise Opportunity Company on whether it should allow the options to expire or exercise them. (7 Marks)
Given below are financial statements (balance sheet and income statement) of OBRETA COMPANY (T), a Tanzanian based subsidiary of a UK company.
Balance Sheet as at 31st December 2006
[Millions of TZS]
_______________________________________________________________________________Cash TZS2,100
Inventory 1,500
Net Fixed Assets 3,000
Total Assets TZS6,600
Current Liabilities 1,200
Long Term Debt 1,800
Common Stock 2,700
Retained Earnings 900
Total Liabilities and Equity TZS6,600
______________________________________________________________________________
Income Statement
For the Year Ended 31st December 2006
[Millions of TZS]
_______________________________________________________________________________Sales Revenue TZS10,000
Cost of Goods Sold 7,500
Depreciation 1,000
Net Operating Income 1,500
Income tax (40%) 600
Profit After Tax 900
Dividends 0
Addition to Retained Earnings 900
______________________________________________________________________________
REQUIRED:
Translate the above financial statements into the currency of the parent company, i.e. the £ at the exchange rate TZS3000/£
QUESTION 2B: [EFFECT OF TRANSLATION METHODS ON FINANCIAL STATEMENTS](a) Translate the balance sheet and income statement of OBRETA COMPANY (T), using the: (i) Current/Non-Current Method (ii) Monetary/Non-Monetary Method (iii) Current Rate Method under the following assumptions:
The TZS appreciates from TZS3000/£ to TZS2000/£
The TZS depreciates from TZS3000/£ to TZS4000/£
(b) Calculate the Translation (Accounting) Exposure
QUESTION 2C: [TRANSLATING FINANCIAL STATEMENTS ACCORDING TO (IFRS)
[ADOPTED FROM WILEY [IFRS] WORKBOOK AND GUIDE ADOPTED]
An entity commenced business on January 1, 20X6, with an opening share capital of $2 million. The income statement and closing balance sheet follow:
Income Statement for the Year ended December 31, 20X6
$m
Revenue 32
Cost of sales (10)
Gross profit 22
Distribution costs (8)
Administrative expenses (2)
Profit before tax 12
Tax expense (4)
Profit for the period 8
Balance Sheet at December 31, 20X6
$m
Share capital 2
Retained Earnings 8
10
Trade Payables 4
Total Equity and Liabilities 14
Land (non-depreciable) acquired December 31, 20X6 8
Inventories 4
Trade Receivables 2
Total Assets 14
The functional currency is the dollar, but the entity wishes to present its financial statements using the euro as its presentational currency. The entity translates the opening share capital at the closing rate. The exchange rates in the period were:
$1=
January 1, 20X6 €1
December 31, 20X6 €2
Average Rate €1.5
REQUIRED:
Translate the financial statements from the functional currency to the presentation currency.
QUESTION 3: [MANAGEMENT OF INTEREST RATE RISK]QUESTION 3A: [NBAA: P17: INTERNATIONAL FINANCE: NOVEMBER 2005: Q3a]
a) Suxess Company, a London based company has £11 million of fixed rate loans at an interest rate of 13% per year which are due to mature in one year. The company’s treasury believes that interest rates are going to fall, but does not wish to redeem the loans because large penalties exist for early redemption. Suxess Company’s bank has offered to arrange an interest rate swap for one year with a company that has obtained floating rate finance at London Interbank Offered Rate (LIBOR) plus 1¼%. The bank will charge each of the companies an arrangement fee of £21,000 and the proposed terms of the swap are that Suxess Company will pay LIBOR plus 1.5% to the other company and receive from the company 11.75%. The corporate tax is at 35% per annum and the arrangement fee is a tax allowable expense.REQUIRED:
Calculate the net interest rate incurred, savings in interest with the swap arrangement, and state whether the swap would be beneficial to Suxess Company assuming that:
i) The LIBOR remains at 10% for the whole year. (5 Marks)
ii) The LIBOR falls to 9% after six months. (5 Marks)
QUESTION 3B: [INTEREST RATE FUTURES: HEDGING INTEREST RATE MOVEMENTS]
Omniown Company wishes to borrow £5,000,000 for six months. The corporate treasurer of Omniown Co. expects interest rate to increase by 2% during the next three months and has decided to hedge the interest rate risk using interest rate futures. March sterling three-month time deposit futures are currently priced at 86.25. The contract size is £500,000 and the minimum price movement is one tick (the value of one tick is 0.01% per year for the contract size).
REQUIRED:
Show the effect of using the futures market to hedge against interest rates movements:
if interest rates increase by 2% and the futures market price also moves by 2%.
If interest rates increase by 2% and futures market moves by 1.5%
If interest rates fall by 1% and futures market moves by 0.75%.
In each case estimate the hedge efficiency. Ignore taxation and time value of money
STQ1: [INTERNATIONAL PORTFOLIO RETURN AND RISK]
A Tanzanian Portfolio Manager is considering the benefits of increasing his diversification by investing overseas. He can purchase shares in individual country funds with the following characteristics:
TANZANIA | UNITED KINGDOM | SPAIN | |
Expected Return | 15 | 12 | |
Standard Deviation | 10 | ||
Correlation with Tanzania | 1.0 | 0.33 | 0.06 |
REQUIRED:
What is the expected return and standard deviation of return of a portfolio with 25% invested in the United Kingdom and 75% in Tanzania?
What is the expected return and standard deviation of return of a portfolio with 25% invested in the Spain and 75% in Tanzania?
What is the expected return and standard deviation of return of a portfolio with 50% invested in the United Kingdom and 50% in Tanzania?
STQ2: [INTERNATIONAL CAPM AND RISK]
Use the following data to answer the questions that follow.
Country | Correlation with Tanzania Market | Standard Deviation of Returns |
TANZANIA | 1.00 | 18.2 |
CANADA | 0.60 | 21.9 |
UNITED KINGDOM | 0.33 | 34.4 |
REQUIRED:
Calculate the foreign market betas relative to the Tanzania market.
Calculate the risk of an internationally diversified portfolio that is equally invested in Tanzania and in each of the individual foreign country markets. State in each case whether the risk of the internationally diversified portfolio is considerably below or above the risk of the Tanzania portfolio.
(i) The initial price of Tanzanian Government bond is TZS950,000 the coupon income is TZS8000 and the end of the period bond price is 970,000. Assume that the Tanzanian shilling appreciates by 3% against the U.S. Dollar during the period. What is the total dollar return on a Tanzanian Government Bond?
(ii) During the first half of the 1990, the Swiss Government bonds yielded a local currency return of –1.6%. However the Swiss Franc rose by 8% against the dollar over this six- month period. Corresponding figures for France were 1.8% and 2.6%.Which bond earned higher U.S. dollar return. What was the return?
(iii) During the first half of the 1990, the Swiss Government bonds yielded a local currency return of –1.6%. However the Swiss Franc rose by 8% against the dollar over this six- month period. Corresponding figures for France were 1.8% and 2.6%. Which bond earned higher U.S. dollar return. What was the return?
(iii) During the year the British Government Bonds went from £102 to £106, while paying a coupon of £9. At the same time, the exchange rate went from US$1.76 to US$1.62. What was the total dollar return, in percent on the British government bond for the year?
STQ3B: [RETURN ON FOREIGN STOCK INVESTMENT](i) ABC is a Tanzanian based company. At the beginning of the year 2000 the Company’s share price was TZS5000, the dividend income was TZS100. The end of the period stock price is TZS4800. During the year the Tanzanian shilling depreciated by 5% against the U.S dollar. Calculate the dollar return on the ABC company’s shares.
(ii) During the year Toyota Motor Company shares went from ¥ 9000 to ¥ 11200, while paying a dividend of ¥ 60. At the same time, the exchange rate went from US$1 = ¥ 145 to US$1 = ¥ 120. What was the total dollar return, in percent, on Toyota stock for the year?
(iii) Here are some data on the stock market returns and exchange rate changes during 2000 for some of the world’s stock markets.
Country | Return in Local Currency | Currency Units per | U.S. Dollar |
(%) | 31/12/1999 | 31/12/2000 | |
Austria | 14.5 | 1.41 | 1.17 |
Tanzania | 25.0 | 800 | 900 |
Canada | 10.9 | 1.29 | 1.20 |
German | 27.9 | 1.68 | 1.85 |
Determine the dollar return on each of these markets
EXAMINATION TYPE QUESTIONS
EQ1: [NBAA P.17: INTERNATIONAL FINANCE: MAY 2007 Q1a]
You are a Portfolio Manager working with a multinational company with a subsidiary in Dar es Salaam. Your Managing Director has provided you with the following returns in three different stock markets. A decision is to be made whether an equally invested portfolio should be formed constituting shares from the three markets. The shares can be purchased in individual country funds.
State of the World | Probability | South Africa (Return in %) | Tanzania (Return in %) | Kenya (Return in %) |
0.1 | 10 | 20 | ||
II | 0.6 | 12 | 22 | |
III | 0.3 | 15 | 16 | 14 |
It has been established that the returns from the three markets are not correlated. Your Managing Director has requested that you should compute the important key parameters of the proposed portfolio to assist him in making the investment decision.
REQUIRED:
(i) Calculate the risk associated with investment in each of the individual capital markets. (6 Marks)
(ii) Based on the above information, calculate the risk and return of the proposed international portfolio. (6 Marks)
State with reasons whether benefits of international portfolio diversification can be achieved in the above proposed international portfolio. (2 Marks)
EQ2: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2006 Q2]
Mega-Mega is a multinational company that has operations in five different developing countries. The investments are each approximately equal in value. The company’s objective is to reduce risk through diversification, and it believes that the return on any investment is not correlated with the return on any other investment. The estimated risk and return of the five investments are shown below:
Country | Risk (Standard Deviation) | Return |
Bangladesh | 14 | |
Congo | 10 | 16 |
Kenya | 12 | |
Tanzania | ||
Uganda | 16 | 22 |
REQUIRED:
Estimate the risk and return of the portfolio of the five investments, and briefly explain the significance of your results. (6 marks)
Discuss the validity to investors of Mega-Mega’s objectives for risk reduction through international diversification. (6 marks)
b) Discuss the main advantages and disadvantages of international portfolio diversification to a multinational company. (8 marks)
EQ3: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2005 Q5b]
A Tanzanian portfolio manager has gathered the following information on three different stock exchanges.
DSM | LONDON | NAIROBI | NEW YORK | |
Expected Return | 12% | 8% | 9% | 10% |
Standard Deviation | 9% | 8.1% | 15.3% | 7% |
Market beta relative to DSM Stock Exchange | 0.9 | 1.7% |
REQUIRED:
Determine whether returns from each of the individual foreign markets are positively or negatively correlated with those of the DSE and state in each case whether the benefit of international portfolio can be attained. (7.5 marks)
Determine the risk of an internationally diversified portfolio which is 75% invested in the Dar es Salaam Stock Exchange and 25% invested in ach of the three foreign markets. (7.5 marks)
EQ4: [NBAA: P17: INTERNATIONAL FINANCE: MAY 2004 Q3b]
MAY 2004 Q3b
A Tanzanian investor invested Tshs. 1,734,000 in a 9% KShs. 1,000 Kenyan Government bond during the year 2003. This bond’s market value changed from KShs. 1020 to KShs.1060 during the year. The Tanzanian inflation rate averaged 20% while that of Uganda averaged 9%. The exchange rate between TSh. And KSh. changed from TShs.10 to TShs.11 and the market value of a 19% TShs10,000 Tanzanian government bond changed from TShs. 17,340 to TShs18,000 during the same period.
REQUIRED:
Assuming the Tanzanian investor held the Kenyan Government bond for one year, what would be the total return in both amounts (Tshs) and in percentage?
What is the best estimate of the one-year forward premium or discount at which the Kenyan Shilling was selling relative to the Ugandan Shilling (Ush.) at the beginning of the year 2003 (round it to the nearest whole number)
If the initial (at the beginning of year 2003) exchange rate for the Tanzanian Shilling (TSh.) was Ushs.3.72/Tsh, calculate the Ush. Value of the TSh at the end of the year 2003. (Assume the IFE holds)