Currency Hedging – NBC Institute

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

Question

You are the Financial Director of Kudi Limited, a Nigerian company that imports raw materials mainly from Tiko (currency: T$) and exports finished products to Katuga (currency: K$). Kudi is partly financed by a loan raised in the domestic market and usually hedges its foreign currency exposure using forward or money markets. Most customers are allowed a 3-month credit. The company recently sold products to a customer in Katuga for K$20 million.

Available Information:

Exchange Rate	K$ per N	T$ per N
Spot Rate	1.9600	1.4600
1 Month Forward	1.9580	1.4579

Central Bank Base Rate Per Annum	Nigeria	Katuga	Tiko
Rate (%)	5.5%	4.25%	3.75%

Required:

(a) Comment on the Interest Rate Parity (IRP) and Purchasing Power Parity (PPP) methods for estimating exchange rates. (6 Marks)

In answering the following questions, include relevant calculations:

Given that interest rates are higher in Nigeria than in Tiko, should T$ be depreciating against the naira and thus trading at a discount? (3 Marks)
Determine the 3-month K$ forward rate of exchange implied by the given information and calculate the naira receipts expected in 3 months from the customer in Katuga. (3 Marks)
Assess whether buying T$ on the spot market now and placing it on deposit would be a sensible policy for Kudi. (3 Marks)

(b) Discuss the concept and significance of foreign exchange economic exposure for a multinational company. (5 Marks)

(Total 20 Marks)

Answer

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Tags: Currency Hedging, Economic Exposure, Financial risk management, Foreign Exchange, Forward Rate, Interest Rate Parity, Multinational Company, Purchasing Power Parity
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2017

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

Question

YSL is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in yen and will total 140 million yen. The managing director of YSL wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:

Spot foreign exchange rate: $1 = 128.15 yen
Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
- Contract size: 12,500,000 yen
- Contract prices (US$ per yen):
  - September: 0.007985
  - December: 0.008250

Assume that futures contracts mature at the end of the month.

Required:
i) Illustrate how YSL might hedge its foreign exchange risk using currency futures. (5 marks)
ii) Explain the meaning of basis risk and show what basis risk is involved in the proposed hedge. (5 marks)
iii) Assuming the spot exchange rate is 120 yen/$1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur. (5 marks)
(Margin requirements and taxation may be ignored.)

Answer

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Tags: Basis risk, Currency Futures, Currency Hedging, Foreign Exchange Risk, Risk Management
Level: Level 3

Topic: Hedging against financial risk: Non-derivative techniques
Series: NOV 2016

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

Question

Edi Ltd, based in Accra, Ghana, is a multinational company with two wholly-owned subsidiaries: Gil Plc based in Nigeria and Zep Ltd based in South Africa. Until recently, the Edi group has been doing well, returning a stable level of dividends to its shareholders. The financial performance of the Edi group has dipped in the past two years. In the last quarter of last year, the directors approved the establishment of a central treasury department based at the group’s headquarters in Accra. It is believed that the central treasury function will help boost effectiveness and efficiency in the group’s liquidity management, currency risk management, dividend remittances, and borrowing.

Intragroup Currency Transfers:
There are a lot of intragroup credit transactions that are often settled independently between the parties involved. This year, the treasury department has been tasked to manage the settlement of intragroup indebtedness through netting to reduce the volume of currency transactions. It has been agreed that all settlements will be made in the Ghanaian cedi at the prevailing spot mid-market exchange rate.

Below is a list of intragroup indebtedness at the end of the first quarter to be settled today:

Required:

i) Suppose the currency netting is implemented. Calculate the intragroup company currency transfers that will be required for settlement by each member of the Edi group.
(6 marks)

ii) Suppose the treasury department is recommending the use of currency futures to hedge net currency exposures. Discuss the advantages and disadvantages of the Edi group using currency options instead of currency futures in hedging net currency exposures.

Answer

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Tags: Currency Futures, Currency Hedging, Currency Transfers, Intragroup Transactions, Multinational Finance, Netting, Treasury Management
Level: Level 3

Topic: The role of the treasury function in multinationals
Series: MAY 2019

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

Question

b) As a trading company, Joewoka exports and imports merchandise in many countries for which it receives and makes payment in foreign currency. This exposes the company to foreign exchange risk.

As a Financial Consultant to the company, suggest FOUR approaches that the company can use to hedge against foreign exchange exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Foreign Exchange Risk, Hedging, Risk Management, Risk Mitigation
Level: Level 3

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

Question

d) ValuePack Ghana Ltd is into the manufacturing and sale of drugs in Ghana. The company imports its raw materials from abroad on credit. The suppliers grant them between 3 months and 6 months credit due to their good track record in payment. The company currently has the following invoices due in:

3 months’ time – USD 2 million
6 months’ time – USD 1 million

They are looking to buy USD/GH¢ forward to hedge their exchange rate risk, and their bank offers them the following forward rates:

3 months – 5.65
6 months – 5.98

The interest rates applicable to their company for both cedi and US dollar for the same tenors are as follows:

Tenor	GH¢ Interest Rate	USD Interest Rate
3 months	15%	2%
6 months	20%	3%

The Spot rate for USD/GH¢ is 5.4 in the market.

Required:
As the newly appointed Finance and Treasury Director of the company, calculate the forward rates for the various tenors based on the information provided above. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Forward Rates, Interest Rate Parity
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: NOV 2019

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

Question

Available Information:

Exchange Rate	K$ per N	T$ per N
Spot Rate	1.9600	1.4600
1 Month Forward	1.9580	1.4579

Central Bank Base Rate Per Annum	Nigeria	Katuga	Tiko
Rate (%)	5.5%	4.25%	3.75%

Required:

(a) Comment on the Interest Rate Parity (IRP) and Purchasing Power Parity (PPP) methods for estimating exchange rates. (6 Marks)

In answering the following questions, include relevant calculations:

Given that interest rates are higher in Nigeria than in Tiko, should T$ be depreciating against the naira and thus trading at a discount? (3 Marks)
Determine the 3-month K$ forward rate of exchange implied by the given information and calculate the naira receipts expected in 3 months from the customer in Katuga. (3 Marks)
Assess whether buying T$ on the spot market now and placing it on deposit would be a sensible policy for Kudi. (3 Marks)

(b) Discuss the concept and significance of foreign exchange economic exposure for a multinational company. (5 Marks)

(Total 20 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Economic Exposure, Financial risk management, Foreign Exchange, Forward Rate, Interest Rate Parity, Multinational Company, Purchasing Power Parity
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2017

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

Question

Spot foreign exchange rate: $1 = 128.15 yen
Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
- Contract size: 12,500,000 yen
- Contract prices (US$ per yen):
  - September: 0.007985
  - December: 0.008250

Assume that futures contracts mature at the end of the month.

Answer

Find Related Questions by Tags, levels, etc.

Tags: Basis risk, Currency Futures, Currency Hedging, Foreign Exchange Risk, Risk Management
Level: Level 3

Topic: Hedging against financial risk: Non-derivative techniques
Series: NOV 2016

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

Question

Below is a list of intragroup indebtedness at the end of the first quarter to be settled today:

Required:

i) Suppose the currency netting is implemented. Calculate the intragroup company currency transfers that will be required for settlement by each member of the Edi group.
(6 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Futures, Currency Hedging, Currency Transfers, Intragroup Transactions, Multinational Finance, Netting, Treasury Management
Level: Level 3

Topic: The role of the treasury function in multinationals
Series: MAY 2019

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

Question

b) As a trading company, Joewoka exports and imports merchandise in many countries for which it receives and makes payment in foreign currency. This exposes the company to foreign exchange risk.

As a Financial Consultant to the company, suggest FOUR approaches that the company can use to hedge against foreign exchange exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Foreign Exchange Risk, Hedging, Risk Management, Risk Mitigation
Level: Level 3

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

Question

3 months’ time – USD 2 million
6 months’ time – USD 1 million

They are looking to buy USD/GH¢ forward to hedge their exchange rate risk, and their bank offers them the following forward rates:

3 months – 5.65
6 months – 5.98

The interest rates applicable to their company for both cedi and US dollar for the same tenors are as follows:

Tenor	GH¢ Interest Rate	USD Interest Rate
3 months	15%	2%
6 months	20%	3%

The Spot rate for USD/GH¢ is 5.4 in the market.

Required:
As the newly appointed Finance and Treasury Director of the company, calculate the forward rates for the various tenors based on the information provided above. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Forward Rates, Interest Rate Parity
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: NOV 2019

Question Tag: Currency Hedging

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FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

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FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

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AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

You're reporting an error for "AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques"

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

You're reporting an error for "AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals"

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

You're reporting an error for "AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives"

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

You're reporting an error for "FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management"

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

You're reporting an error for "FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management"

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

You're reporting an error for "AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques"

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

You're reporting an error for "AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals"

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

You're reporting an error for "AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives"

FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management

Calculate the forward rates for USD/GH¢ based on interest rate parity.

You're reporting an error for "FM – Nov 2019 – L2 – Q3d – Foreign exchange risk and currency risk management"

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