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Practice Questions

The document discusses five exercises involving financial risk management and hedging currency risk for various UK companies trading internationally. The exercises provide spot and forward exchange rate quotes and future contract prices to use when calculating and recommending hedging strategies.

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kashif mahmood
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41 views4 pages

Practice Questions

The document discusses five exercises involving financial risk management and hedging currency risk for various UK companies trading internationally. The exercises provide spot and forward exchange rate quotes and future contract prices to use when calculating and recommending hedging strategies.

Uploaded by

kashif mahmood
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

FINANCIAL RISK MANAGEMENT

EXERCISE 1

National plc is a UK based company that regularly trades with companies in the USA. National
plc has exported goods worth $ 120 M which is receivable in five months’ time. Assume that it is
now 1 June and Spot exchange rates are 1·8156 – 1·8210

Exchange rates $US/£

October Forward 1·8066 – 1·8120

December Forward 1·7901 – 1·7945

Following information about future contracts is also available

Chicago Money Exchange $/£ Currency futures (£62,500)

September 1·8035

December 1·7965

Assume futures contracts mature at the relevant month end

Required:

Prepare a report for the managers of National plc on how the five-month currency risk should be
hedged. Include in your report all relevant calculations relating to the alternative types of hedge.

EXERCISE 2

Friends plc is a UK based company that regularly trades with companies in the USA. Several
large transactions are due in four months’ time. These are shown below. The transactions are in
‘000’ units of the currencies shown. Assume that it is now 1 July and that futures and options
contracts mature at the relevant month end.
EXPORTS TO IMPORTS FROM
ABC CO $490 $150
Exchange Rates
$US/£
Spot 1·5166 – 1·5230
3 months forward 1·5086 – 1·5150
6 month forward 1·4901 – 1·4945
CME $/£ Currency futures (£75,500)
September 1·5045
December 1·4986
CME currency options prices, $/£ options £31,250 (cents per pound)
Strike Price CALL PUT
September December September December
1.5000 3.55 4.50 2.30 4.50
1.5200 2.38 3.76 3.50 6.50
Required:
Prepare a report for the managers of Friends plc on how the five-month risk should be hedged by
using financial derivatives.
EXERCISE 3

Exchange rates $US/£


Spot 1·9156 – 1·9210
November forward 1·9066 – 1·9120
December forward 1·8901 – 1·8945
Lammer plc is a UK based company that regularly trades with companies in the USA. Lammer
plc has exported goods worth $ 120 M which is receivable in five months’ time. These are shown
below. Assume that it is now 1 June and that futures contracts mature at the relevant month end.
Annual interest rates available to Lammer plc
Borrowing Investing
UK 5·5% 4·2%
US 4·0% 2·0%
Chicago Money Exchange $/£ Currency futures (£62,500)
September 1·9045
December 1·8986
Prepare a report for the managers of Lammer plc on how the five-month currency risk should be
hedged. Include in your report all relevant calculations relating to the alternative types of hedge.
EXERCISE 4

Tertial plc of UK has recently commenced exports to Blundonia, a developing country. A


payment of 100 million pesos is due from a customer in Blundonia in three months’ time. The
Blundonian government sometimes restricts the movement of funds from the country, but has
indicated that payment to Tertial has a good chance of receiving approval. No forward market or
derivatives markets exist for the Blundonian peso.
The Blundonian peso is currently linked to the US dollar.
Exchange rates:
Spot rate B peso/$ 126·4 – 128·2
Spot rate$/£ 1·775 – 1·782
3 month forward rate B peso/£ Not available
3 month forward rate $/£ 1·781 – 1·789

Tertial can borrow at 6% per annum or invest at 4% per annum in the UK, can borrow at 7% and
invest at 4·5% in the USA, and at 14% and 10% respectively in Blundonia. Tertial currently has
a £800,000 overdraft in the UK.
Inflation rates:
UK 3%
USA 4%
Blundonia 14%
Tertial’s Blundonian customer has indicated that it might be willing to make a lead payment in
return for a 1·5% discount on the sale price.
Required:
 Discuss the advantages and disadvantages of the alternative currency hedges that are
available to Tertial.
 Calculate the expected outcome of each hedge, and recommend which hedge should be
selected.

EXERCISE 5
Friends Inc. is a German company which trades frequently with Switzerland and USA.
Transaction to be completed within next six months is as follows.
Receipts Payments
3 Months Time $3.8 M $1.8M
6 Months Time SF5.5M SF7.5M
Exchange Rates in Paris
SF / Euro $ /Euro
Spot 1.5974- 1.6000 0.9380-0.9425
3 month forward 1.6048- 1.6074 0.9333-0.9384
6 month forward 1.6108- 1.6137 0.9310-0.9361

Euro market traded option prices (62500 euro contract size) in the USA
(The options relate to the purchase or sale of euros)
Exercise June Contracts September Contracts
price($/Euro)
Calls Puts Calls Puts
0.936 1.65 0.41 2.38 0.71
0.938 0.56 1.20 1.01 1.57
0.940 0.17 2.65 0.48 3.45
Option premium is in cents per euro and are payable upfront. The options are American style.
Assume that it is now 1 June and option contracts mature on the end of month.
Required:
Discuss, with supporting calculations, how Friend Inc hedges its foreign exchange risk during
next six months. Include in your discussion comment about which currency options contracts
might be best for Friend Inc. The company does not wish to take significant risk and wishes to
accumulate as high a cash flow as possible from its possible transactions.

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