Reference no: EM133061538

SECTION A

Question 1

a) MMA plc., is a UK-based manufacturer of heavy machine components for the power industry. MMA exports a significant proportion of its products to clients in the US. In order to compete with other US suppliers of heavy machine components, MMA prices its exports in US dollars. It is March 2021 and MMA has just shipped a large consignment worth $50 million to TLP Inc., one of MMA's major clients in the US. Payment for this shipment is due in 90-days.

MMA treasury department is concerned about the recent volatility of the dollar- pound exchange rates and has suggested that its exposure to the US dollar should be hedged.

The following currency and money market quotes are available today:

Spot Rate (bid - ask): US$1.5077/£ - US$1.5379/£
Barclays 90-day forward quote ((bid - ask): US$1.5025/£ - US$1.5432
90-day dollar deposit interest rate: 0.8% per annum
90-day pound deposit interest: 1.2% per annum
90-day US dollar borrowing rate: 1.2% per annum
90-day pound borrowing rate: 1.8% per annum

Given the information above, which hedging alternative would be preferable? Please show all relevant workings in support of your recommendation.

b) A year ago, the pound was trading at 515 Nigerian nairas (NGN) per pound and 93 Indian rupees (INR) per pound. Today, the pound is trading at NGN 530/£ and INR 100/£.

Calculate the cross rates for the naira per rupee at the two dates and determine the percentage appreciation or depreciation of the Indian rupee relative to the Nigerian naira.

Question 2

a) Mac Ltd is a UK-based company. It has to pay 70 million euros in 180-days to its suppliers in France. The euro is expected to appreciate against £ 1.5%. Historically, the standard deviation euro/£ exchange rate has been 7%.

Assume the exchange rate today is £0.86

i. If the spot exchange rate change in 180-days turns out to be as expected, how much will Mac Ltd have to pay in Sterling Pounds?

ii. Calculate the maximum percentage loss with 95% confidence level that Mac could be exposed to over the 180-day period if it does not hedge this exposure.
(Hint: z95 =1.645; z99 =2.326)

iii Calculate the pound value of the maximum increase in payment at 95% confidence level, that Mac could suffer over the 180-day period if it does not hedge its exposure

b) As a currency trader, you identify the following exchange rate and money market quotes from two different dealers:

1-year euro deposits/loans:	6.0% - 6.125% p.a.
1-year Malaysian ringgit deposits/loans:	10.5% - 10.625% p.a.
Spot exchange rates:	MYR 4.6602 / EUR - MYR 4.6622 / EUR
1-year forward exchange rates:	MYR 4.9500 / EUR - MYR 4.9650 / EUR

i. Is there an opportunity for covered interest arbitrage (with zero net investment)? Please show all relevant workings in support of your answer.

ii. Hence determine the range of forward rates for which there will be no arbitrage opportunity.

Question 3

a) Suppose SemCo Ltd (a UK Company) has payables of US$40 million due in 90 days from now. Over-the-counter put and call options on US dollars, both at an exercise price of £0.72 per US$, are available for a premium of £0.03 and £0.04 per US$ respectively. If SemCo decides to hedge using options, the required premium for the option used will be paid from an overdraft account on which it pays 6% per annum.

i. Calculate the values if the company chooses the options hedge is used

ii. A 90-day forward contract is available at £0.75/$. Determine the exchange rate at which SemCo Ltd would be indifferent between the options and the forward hedge.

a) As a Treasurer of SemCo Ltd you would like to use currency futures contracts to hedge US$40million that you owe to the supplier in June. A futures quote of £0.74/$ for June delivery is available on International Money Market. The contract size is US$125,000.

You decide to take a position in the futures to hedge exposure to the US$. In June the relevant futures contract is trading £0.76/$. Ignoring margin, was it good that you hedged using futures if the spot exchange rate in June is £75/$? How much is the profit or loss on the futures position?

Question 4

a) Datson is a US based automotive parts supplier which has annual sales of over US$26 bn. Datson has expanded its markets far beyond traditional automobile manufacturers to diversify its sales base. As part of the general diversification efforts, Datson wishes to diversify its debt portfolio as well. Datson enters into a US$50 million swap where it agrees to pay Euro cash flows and receive US Dollar cash flows using the following quotes and information:

		Values		Swap Rates	5- year bid	5-year ask
Notional principal		50,000,000		US $	5.86%	5.89%
Spot exchange rate, $/€		1.16		Euros	4.01%	4.05%

(i) Show via a diagram, how this swap will work. Calculate all cash flows in both currencies over entire 5 years.

(ii) Assume that after two years, Datson decides to unwind the swap. If 3-year fixed rate in Euro has now risen to 5.05% and 3-year US$ fixed rate has fallen to 4.40%, and current spot rate is $1.12/€, should Datson unwind the swap? How much would Datson will pay or receive?

SECTION B
Answer any TWO questions from this Section.

Question 5

a) Briefly discuss the potential benefits and risks of a pegged currency system? Using the exchange rate regimes of the UK (floating) and China (pegged), discuss the pros and cons of floating v pegged currency regimes.

b) The purchasing power parity (PPP), interest rate parity (IRP) and international Fisher effect (IFE) are three parity conditions often encountered in the literature. Briefly discuss the implications of these parity conditions and show the interrelationship between them.

Question 6

a) Evaluate the arguments for and against a firm pursuing an active currency risk management program.

b) Distinguish between losses from transaction exposure, operating exposure, and translation exposure? Use examples to illustrate your answer.

Question 7

a) Discuss the important factors one should consider in the international capital budgeting process to be undertaken by a multinational firm.

b) In what ways real option analysis is superior to the traditional capital budgeting in making investment decisions?